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  5. How Competitive Is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

How Competitive Is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing

  • Valentin Haddad
  • Paul Huebner
  • Erik Loualiche
American Economic Review
vol. 115, no. 3, March 2025
(pp. 975–1018)
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Abstract

The conventional wisdom in finance is that competition is fierce among investors: if a group changes its behavior, others adjust their strategies such that nothing happens to prices. We estimate a demand system with flexible strategic responses for institutional investors in the US stock market. When less aggressive traders surround an investor, she adjusts by trading more aggressively. However, this strategic reaction only counteracts two-thirds of the impact of the initial change in behavior. In light of these estimates, the rise in passive investing over the last 20 years has made the demand for individual stocks 11 percent more inelastic.

Citation

Haddad, Valentin, Paul Huebner, and Erik Loualiche. 2025. "How Competitive Is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing." American Economic Review 115 (3): 975–1018. DOI: 10.1257/aer.20230505

Additional Materials

JEL Classification

  • G11 Portfolio Choice; Investment Decisions
  • G14 Information and Market Efficiency; Event Studies; Insider Trading
  • G23 Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors
  • G41 Behavioral Finance: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets [Neurofinance]