The Shift from Active to Passive Investing: Potential Risks to Financial Stability?

Kenechukwu Anadu (), Mathias S. Kruttli, Patrick E. McCabe and Emilio Osambela
Additional contact information
Patrick E. McCabe: https://www.federalreserve.gov/econres/patrick-e-mccabe.htm
Emilio Osambela: https://www.federalreserve.gov/econres/emilio-osambela.htm

No 2018-060r1, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: The past couple of decades have seen a significant shift in assets from active to passive investment strategies. We examine the potential effects of this shift for financial stability through four different channels: (1) effects on investment funds’ liquidity transformation and redemption risks; (2) passive strategies that amplify market volatility; (3) increases in asset-management industry concentration; and (4) the effects on valuations, volatility, and comovement of assets that are included in indexes. Overall, the shift from active to passive investment strategies appears to be increasing some types of risk while diminishing others: The shift has probably reduced liquidity transformation risks, although some passive strategies amplify market volatility, and passive-fund growth is increasing asset-management industry concentration. We find mixed evidence that passive investing is contributing to the comovement of asset returns and liquidity.

Keywords: Financial stability; Market volatility; Asset management; Daily rebalancing; Indexing; Systemic risk; Passive investing; Mutual fund; Leveraged and inverse exchange-traded products; Exchange-traded fund; Index investing; Inclusion effects (search for similar items in EconPapers)
JEL-codes: G10 G11 G20 G23 G32 L1 (search for similar items in EconPapers)
Pages: 34
Date: 2018-08-28, Revised 2020-06-29
New Economics Papers: this item is included in nep-cfn and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Related works:
Working Paper: The Shift from Active to Passive Investing: Potential Risks to Financial Stability? (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2018-60

DOI: 10.17016/FEDS.2018.060r1

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