Effects of Passive Intensity on Aggregate Price Dynamics

Sina Ehsani and Donald Lien

The Financial Review, 2015, vol. 50, issue 3, 363-391

Abstract: We find that passive intensity (PI), measured by the passive-linked share of total stock market trading volume, is strongly related to the overall pattern of stock price movements. A one-standard-deviation increase in PI is associated with an 8% higher price synchronicity. We further investigate the channels through which this relation is established by separately analyzing its impact on aggregate systematic and idiosyncratic volatility of stock returns. PI has a positive effect on systematic volatility and a negative impact on firm-specific volatility. Consistent with the effect of passive trading on price dynamics, we find evidence that PI is negatively associated with mutual funds alpha dissimilarity. After controlling for market and idiosyncratic volatility, a one-standard-deviation increase in PI corresponds to a 0.20% decrease in fund dissimilarity. Our findings are robust after controlling for various macro and corporate factors known to affect systematic or firm-specific volatility.

Date: 2015
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