Tuesday, 14 June 2022 04:10

Passive Investing Driving Market Volatility

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There is no hiding the huge influx in passive investing over the last couple of decades as a direct result of the ETF boom, but the rise in passive investing is causing more market volatility according to a new academic study. Theoretically with more passive investors active traders will become more aggressive and individual stock demand should be unchanged, but according to the study by UCLA it has increased market vitality and reduced efficiency. Even the skyrocketing number of algorithmic traders can’t offset the passive investors. Markets have far fewer signals and traders to rely on to gain underlying information about a stock, which creates an empty void that is filled up with volatility. Moreover, the paper speculates that as more ESG funds popup this will exacerbate the passive volatility problem.

Finsum: Passive investing has surely increased the average trader's utility, but it comes at the cost of a more efficient market and higher future volatility.

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