Limits to Diversification: Passive Investing and Market Risk
Lily H. Fang (INSEAD), et al.
September 2024
We show that the rise of passive investing leads to higher correlations among stocks and increased market volatility, thereby limiting the benefit of diversification. The extent to which a stock is held by passive funds (index mutual funds and ETFs) positively predicts its beta, correlation, and covariance with other stocks, but not its idiosyncratic volatility. During crisis periods, stocks with high passive holdings contribute more to market risk compared to before the crisis. Correlated trading by passive funds explains these results, which are further amplified by implicit indexing due to performance benchmarking.
Daily Archives: December 6, 2024
Macro Briefing: 6 December 2024
US jobless claims rose to a six-week high last week, but remain near the lows of recent history, which suggests the outlook for the labor market is still relatively upbeat. The number of Americans filing for unemployment benefits increased to 224,000 on a seasonally adjusted basis, the highest since mid-October.
