Who Clears the Market When Passive Investors Trade?

By: Marco Sammon and John J. Shim

Format:Print
| Language:English
| Pages:98

Abstract

We find that firms are the primary sellers of shares when index funds are net buyers, providing shares at a nearly one-for-one rate. Rather than provide liquidity, most demand-side institutions trade in the same direction as index funds, especially over long horizons. To establish causality, we develop a novel instrument for inelastic index fund demand, and show that firms are the most responsive, with prices as the coordinating mechanism. We show evidence consistent with stock compensation as the main source of firm issuance to satisfy passive demand, consistent with firms clearing the market for index fund buying but not selling.