We develop a framework to theoretically and empirically analyze investor competition on financial markets. The standard view assumes that markets are very competitive: if an investor is impaired, others step in, leaving market outcomes the same. In our setting, varying degrees of competition are possible. With less competition, changes in market structure do impact prices. For example, if a group of investors becomes less active — such has mutual funds moving towards passive portfolios, or financial intermediaries becoming distressed — the demand for stocks becomes more inelastic. Consequently, volatility increases, and price informativeness decreases. We estimate the degree of competition from portfolio data by using a two-layer demand system. Competition is weak: it compensates only 30% of the direct effect of removing investors. We highlight the consequences of this result for secular trends in investor behavior such as the rise of passive investing.
Valentin Haddad's website
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