Passive Investing and Market Quality

65 Pages Posted: 5 Oct 2023 Last revised: 19 Mar 2024

See all articles by Philipp Höfler

Philipp Höfler

Goethe University Frankfurt - Department of Finance

Christian Schlag

Goethe University Frankfurt; Leibniz Institute for Financial Research SAFE

Maik Schmeling

Goethe University Frankfurt - Department of Finance; Centre for Economic Policy Research (CEPR)

Date Written: September 11, 2023

Abstract

We show that an increase in passive exchange-traded fund (ETF) ownership leads to stronger and more persistent return reversals. Exploiting exogenous changes due to index reconstitutions, we further show that more passive ownership causes higher bid-ask spreads, more exposure to aggregate liquidity shocks, more idiosyncratic volatility, and higher tail risk. We examine potential drivers of these results and show that higher passive ETF ownership reduces the importance of firm-specific information for returns but increases the importance of transitory noise and a firm's exposure to market-wide sentiment shocks.

Keywords: passive investing, ETFs, market efficiency, reversal

JEL Classification: G12, G14

Suggested Citation

Höfler, Philipp and Schlag, Christian and Schmeling, Maik, Passive Investing and Market Quality (September 11, 2023). Available at SSRN: https://ssrn.com/abstract=4567751 or http://dx.doi.org/10.2139/ssrn.4567751

Philipp Höfler

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

Christian Schlag

Goethe University Frankfurt ( email )

Faculty of Economics and Business
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Maik Schmeling (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

HOME PAGE: http://sites.google.com/site/maikschmeling/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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