Comovement, Passive Investing and Price Informativeness

Abstract

From 1992 to 2011, average R2 increased from 0.17 to 0.47. During this period, passive financial institutions also grew their ownership from 30 to 50% of the market. Passive investors do not perform fundamental research nor trade around firm-specific news, thus reducing the firm-specific component of total volatility. As a result, prices comove more strongly with each other and reveal less information. Consistent with this conjecture, we find that comovement’s rise since the early 1990s is largely driven by the growth in passive institutional ownership as prices of stocks predominantly owned by passive institutions contain less information about future earnings.

Keywords: comovement, volatility, informed trading, correlated trading, passive investing, institutional ownership, price informativeness

JEL Classification: G10, G12, G14, G15, G18