The Paradox of Market Efficiency: Unpacking the Passive Investment Boom
In a week that defied the principles of market efficiency, stock trading has presented an intriguing paradox. Notably, Bloomberg describes how significant drops in major equity gauges on Monday, driven by fears surrounding a new AI model, were followed by rapid recoveries. A new academic paper attributes this phenomenon to the growing prevalence of passive investing, which may be contributing to volatile market movements.
The study, slated for publication in the American Economic Review, presents evidence that active managers are becoming increasingly sluggish in responding to stock price changes when they diverge from intrinsic values. This inertia, coupled with the persistent surge of index funds that track benchmarks, amplifies the impact of individual trades on prices. Such was potentially the case on Monday when sell orders triggered wider market fluctuations.
Risks of the Passive Investment Boom
According to research from the UCLA Anderson School of Management, Stockholm School of Economics, and the University of Minnesota Carlson School of Management, the dominance of passive investing has ushered in a financial environment characterized by decreased dynamic ability and increased volatility. Valentin Haddad, a finance professor at UCLA and co-author of the study, critiques the 'magical thinking' behind efficient market theories, stating that if a portion of investors adopt passive strategies without any change in behavior from active investors, market prices will see reduced stability.
The paper argues that we are witnessing a crucial shift where the overall investor sensitivity to price changes, known as demand elasticity, has diminished by 11% over the past two decades due to the passive investing trend. As a result, fewer active investors are purchasing stocks en masse, even when these stocks are perceived to be undervalued, thus disrupting market stability and liquidity. This coincides with the increase in stock index fund inflows, which amounted to $585 billion in 2022, continuing a historic shift towards passive investing over active management.
Market Implications
Though the study stops short of declaring the market definitively inefficient, it raises concerns about passive investments' latent potential to destabilize markets. Critics like Michael Green highlight that larger stocks, having lower elasticity, are more susceptible to significant price movements, complicating efforts to correct any misvaluations.
Nonetheless, Haddad acknowledges the nuanced implications of this research, recognizing that while most individual investors might gain from the rise of index funds, there are growing indications that the passive trend could influence the fundamental role of markets in resource allocation.
"If the price drops for non-fundamental reasons, ideally, someone should intervene to stabilize prices, but the lack of elasticity due to passive investing undermines this mechanism," Haddad explains, highlighting the evolving challenges within today's financial markets.
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1. INTRODUCTION
Making Data-Driven Decisions to Grow Your Business
- REPORT DESCRIPTION
- RESEARCH METHODOLOGY AND AI PLATFORM
- DATA-DRIVEN DECISIONS FOR YOUR BUSINESS
- GLOSSARY AND SPECIFIC TERMS
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2. EXECUTIVE SUMMARY
A Quick Overview of Market Performance
- KEY FINDINGS
- MARKET TRENDS This Chapter is Available Only for the Professional Edition PRO
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3. MARKET OVERVIEW
Understanding the Current State of The Market and Its Prospects
- MARKET SIZE
- CONSUMPTION BY COUNTRY
- MARKET FORECAST TO 2030
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4. MOST PROMISING PRODUCT
Finding New Products to Diversify Your Business
This Chapter is Available Only for the Professional Edition PRO- TOP PRODUCTS TO DIVERSIFY YOUR BUSINESS
- BEST-SELLING PRODUCTS
- MOST CONSUMED PRODUCT
- MOST TRADED PRODUCT
- MOST PROFITABLE PRODUCT FOR EXPORT
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5. MOST PROMISING SUPPLYING COUNTRIES
Choosing the Best Countries to Establish Your Sustainable Supply Chain
This Chapter is Available Only for the Professional Edition PRO- TOP COUNTRIES TO SOURCE YOUR PRODUCT
- TOP PRODUCING COUNTRIES
- TOP EXPORTING COUNTRIES
- LOW-COST EXPORTING COUNTRIES
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6. MOST PROMISING OVERSEAS MARKETS
Choosing the Best Countries to Boost Your Exports
This Chapter is Available Only for the Professional Edition PRO- TOP OVERSEAS MARKETS FOR EXPORTING YOUR PRODUCT
- TOP CONSUMING MARKETS
- UNSATURATED MARKETS
- TOP IMPORTING MARKETS
- MOST PROFITABLE MARKETS
7. GLOBAL PRODUCTION
The Latest Trends and Insights into The Industry
- PRODUCTION VOLUME AND VALUE
- PRODUCTION BY COUNTRY
8. GLOBAL IMPORTS
The Largest Importers on The Market and How They Succeed
- IMPORTS FROM 2012–2024
- IMPORTS BY COUNTRY
- IMPORT PRICES BY COUNTRY
9. GLOBAL EXPORTS
The Largest Exporters on The Market and How They Succeed
- EXPORTS FROM 2012–2024
- EXPORTS BY COUNTRY
- EXPORT PRICES BY COUNTRY
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10. PROFILES OF MAJOR PRODUCERS
The Largest Producers on The Market and Their Profiles
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11. COUNTRY PROFILES
The Largest Markets And Their Profiles
This Chapter is Available Only for the Professional Edition PRO- United States
- China
- Japan
- Germany
- United Kingdom
- France
- Brazil
- Italy
- Russian Federation
- India
- Canada
- Australia
- Republic of Korea
- Spain
- Mexico
- Indonesia
- Netherlands
- Turkey
- Saudi Arabia
- Switzerland
- Sweden
- Nigeria
- Poland
- Belgium
- Argentina
- Norway
- Austria
- Thailand
- United Arab Emirates
- Colombia
- Denmark
- South Africa
- Malaysia
- Israel
- Singapore
- Egypt
- Philippines
- Finland
- Chile
- Ireland
- Pakistan
- Greece
- Portugal
- Kazakhstan
- Algeria
- Czech Republic
- Qatar
- Peru
- Romania
- Vietnam
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LIST OF TABLES
- Key Findings In 2024
- Market Volume, In Physical Terms, 2012–2024
- Market Value, 2012–2024
- Per Capita Consumption, By Country, 2018–2024
- Production, In Physical Terms, By Country, 2012–2024
- Imports, In Physical Terms, By Country, 2012–2024
- Imports, In Value Terms, By Country, 2012–2024
- Import Prices, By Country Of Destination, 2012–2024
- Exports, In Physical Terms, By Country, 2012–2024
- Exports, In Value Terms, By Country, 2012–2024
- Export Prices, By Country Of Origin, 2012–2024
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LIST OF FIGURES
- Market Volume, In Physical Terms, 2012–2024
- Market Value, 2012–2024
- Consumption, By Country, 2024
- Market Volume Forecast to 2030
- Market Value Forecast to 2030
- Products: Market Size And Growth, By Type
- Products: Average Per Capita Consumption, By Type
- Products: Exports And Growth, By Type
- Products: Export Prices And Growth, By Type
- Production Volume And Growth
- Exports And Growth
- Export Prices And Growth
- Market Size And Growth
- Per Capita Consumption
- Imports And Growth
- Import Prices
- Production, In Physical Terms, 2012–2024
- Production, In Value Terms, 2012–2024
- Production, By Country, 2024
- Production, In Physical Terms, By Country, 2012–2024
- Imports, In Physical Terms, 2012–2024
- Imports, In Value Terms, 2012–2024
- Imports, In Physical Terms, By Country, 2024
- Imports, In Physical Terms, By Country, 2012–2024
- Imports, In Value Terms, By Country, 2012–2024
- Import Prices, By Country, 2012–2024
- Exports, In Physical Terms, 2012–2024
- Exports, In Value Terms, 2012–2024
- Exports, In Physical Terms, By Country, 2024
- Exports, In Physical Terms, By Country, 2012–2024
- Exports, In Value Terms, By Country, 2012–2024
- Export Prices, 2012–2024
