How index trading increases market vulnerability by the effect of rising of passive investment by the study of xiong in 2011

2. HYPOTHESIS OF THE ARTICLE
•THE RESEARCHER FOUND THAT PASSIVELY MANAGED INVESTMENT INCLUDED EQUITY MUTUAL
FUND AND EXCHANGE RATE (ETFS) HAVE INCREASED IN GROWTH TO REACH MORE THAN $1
TRILLION IN 2010.
•THE INCREASING IN THE POPULARITY OF THE INDEX TRADING LEAD TO HIGHER SYSTEMATIC RISK
IN THE MARKET, INCREASED IN CROSS-SECTIONAL TRADING COMMONALITY, AND HIGHER RETURN
CORRELATION AMONG STOCKS.
•THE MORE POPULARITY OF PASSIVE TRADING CAUSE THE BETA OF EQUITY TO INCREASE IN RECENT
YEAR DURING THE PERIOD OF STUDY.
•IN U.S. STOCK MARKET, THE RESEARCHER FOUND THAT THIS MARKET BECOME MORE VULNERABLE .

3. DATA COLLECTION
•COLLECT DATA FROM STOCKS THAT MEET CRITERIA ON NYSE, AMEX AND NASDAQ FROM 1 JANUARY
1979 TO 1 DECEMBER 2010
•BY LOOK AT THE DAILY RETURN AND DAILY EXCHANGE BASED ON TRADING VOLUME MONTHLY
MARKET CAPS, MONTHLY BOOK TO MARKET RATIOS AND NO. OF SHARE OUTSTANDING DIRECT
FROM MORNINGSTAR DATABASE.
•THE STUDY ALSO INCLUDE U.S EQUITY ETFS FUNDS AND U.S. MUTUAL FUND BOTH LIVE AND
DEFUNCT FUND.

4. FACTORS OF MARKET VULNERABLE
1. THE RISE OF SYSTEMATIC MARKET RISK (BETA)
2. THE INCREASED PORTION OF PASSIVE BASKET TRADING IN INDEX MUTUAL FUNDS AND ETFS
3. THE RISING IN MARKET EFFICIENCY

5. 1. THE RISE OF SYSTEMATIC MARKET RISK (BETA)
•THE INCREASING OF INSTITUTIONAL OWNERSHIP CAUSE THE RISING IN SIZE, LIQUIDITY BETAS,
RETURN BETAS AND EFFICIENCY OF PRICE INFORMATION BUT INTRADAY VOLATILITY DECREASED.
2. THE RISING IN THE POPULATION OF PASSIVE
MANAGED ASSETS
•THE GROWTH OF INDEX MUTUAL FUND THAT OFFER LOW COST WITH VARIOUS SEGMENT OF
DIVERSIFICATION AND ETFS THAT ALLOW INTRADAY TRADING BASIS FOR ACTIVE MANAGED
INVESTMENT CAUSE THE INCREASING IN COST ON COMMONALITY STOCK TRADING FROM
CONTINUOUS BUYING AND SELLING LEAD TO THE UNWANTED AFFECTED ON THE MARKET.

6. 3. THE RISING IN MARKET EFFICIENCY
•MARKET TEND TO BE MORE VOLATILE AND MORE EFFICIENT DUE TO THE PARTICIPANT REACT IN THE
SAME WAY WHEN UNANTICIPATED NEW INFORMATION AVAILABLE IN PUBLIC CAUSE THE LARGE
SWING IN IN MARKET PRICE.

7. FIGURE 1 : EQUAL WEIGHTED AVERAGE BATAS FOR
U.S. STOCKS BY SIZE AND STYLE
• THE RISE IN SYSTEMATIC RISK
RELATED TO THE RISE IN POPULARITY
OF PASSIVE MANAGED INDEX FUND
• INCREASING IN COMMONALITY
TRADING STOCKS THAT CAUSE THE
IMPACT ON SYSTEMATIC MARKET
RISK.
• INDEX INVESTING DISTORT THE
STOCK PRICE AND RISK RETURN
TRADE OFF

8. THE GROWTH OF INDEX TRADING
• THE EQUITY SHARES HOLD BY THE INSTITUTION INCREASED FROM 24 PERCENT IN 1980 TO 44 PERCENT IN 2000 AND
REACH 70 PERCENT IN 2010.
YEAR 1980 : 24% > YEAR 2000 : 44% > YEAR 2010 : 70%
• THE AVERAGE NUMBER OF INSTITUTION HOLDING TYPICAL FIRM SHARES IN NYSE GROWN FROM 54 INSTITUTIONS IN
1980 TO 125 IN 2000 AND REACH TO 405 IN 2010. THE NYSE MAIN TRADING ACTIVITIES BELONG TO INSTITUTIONAL
TRADING ACCOUNT OVER 70 PERCENT OF TRADING VOLUME.
YEAR 1980 : 54 > YEAR 2000 : 125 > YEAR 2010 : 405

9. FIGURE 2 : GROWTH IN EQUITY FUND ASSETS BY
TYPE OF FUND
• PANEL A : TOTAL DOLLAR GROWTH
•PASSIVE MANAGED INVESTMENT
AS INDEX MUTUAL FUND PLUS ETFS
HAVE REACHED $3.5 TRILLION IN
OCTOBER 2010

10. FIGURE 2 : GROWTH IN EQUITY FUND ASSETS BY
TYPE OF FUND
• PANEL B : FUND TYPE BY PERCENT OF TOTAL ASSETS
•THE PASSIVE FUND INCREASED
MARKET SHARE AGAINST ACTIVE
FUND OVER THE LAST TWO
DECADES

11. THE VANGUARD 500 INDEX (VFIAX)
•THE VANGUARD 500 INDEX (VFIAX) CAN HELP RESEARCHERS TO UNDERSTAND THE POTENTIAL
IMPACT OF INDEX
•THE REASON IS THE COMPANY TRADING ON THE MARKET AS ONE OF THE LARGEST INDEX MUTUAL
FUND THAT HAS ABOUT $106 BILLION ASSET AND HOLD AROUND 500 STOCKS
•THE TRADING ACTIVITY FROM THIS MUTUAL FUND REPRESENT 400 PERCENT OF TYPICAL DAILY
VOLUME THAT STOCK.

12. FIGURE 3 : ETFS SHARE OF TOTAL U.S. TRADE VOLUME
MARCH 2000 – SEPT 2011
•ETFS SHARE OF U.S. TRADE VOLUME
RISE FROM 2000 UNTIL NOW,
•TRADING VOLUME INCREASED ABOUT
30 PERCENT OF TOTAL DOLLAR AND
INCREASED 20 PERCENT OF TOTAL
SHARE VOLUME.
•ETFS BECOME THE KEY INSTRUMENT
FOR INVESTOR TO NOTIFY IMPACT ON
THE MARKET IN TRADE VOLUME AND
MARKET PRICE.

13. MEASURING TRADING COMMONALITY
•INDEX FUND THAT INCLUDE BOTH ETFS AND MUTUAL FUNDS BUY AND SELL GROUPS OF STOCKS
VIA BASKET THAT RESPONSE TO THE CAPITAL INFLOW AND OUTFLOW TO IMPACT IN PRICE IN
DIFFERENT SPREAD TIME.
•THE INDEX MANAGER ATTEMPTS TO MITIGATE THE MARKET IMPACT BY SPREADING REQUIRED
ORDER FLOW OVER TIME.
•THE IMPACT OF CROSS-SECTIONAL DISPERSION OF TRADING VOLUME ON MARKET ACTIVITY BY
CALCULATING THE DERIVATION OF VCT AS MEASURED ACROSS ALL STOCK AT EACH TIME PERIOD
(T)
•THE EQUATION VCT = LN [ V(T) / V(T-1) ].

14. FIGURE 4 : CROSS-SECTIONAL DISPERSION OF TRADING
VOLUME CHANGE VS GROWTH OF PASSIVE ASSETS
• THE RESULT SHOWN THAT THERE ARE
2 PART
• FIRST PART IN FLAT GRAPH FROM
1997 TO 1996 AND DECLINE IN
SECOND PART AT ALMOST CONSTANT
RATE.
• AT SECOND REGIME INDEX
INVESTMENT BEGAN POPULARITY BY
ETFS TRADE ACTIVITY, AS THE
INCREASE IN INDEX TRADING DRIVES
HIGHER RETURN COVARIANCE IN
CONSTITUENT STOCKS.

15. THE SOURCES OF PHENOMENON
1. FROM OVERALL GROWTH IN INSTITUTIONAL ASSET
2. THE ACTIVE MUTUAL FUNDS THAT MANAGED AGAINST AN INDEX BENCHMARK AND CONTRIBUTE
TO THE INCREASED IN SYSTEMATIC MARKET RISK.
3. THE RISE OF INSTITUTIONAL INVESTOR THAT SHOWN THEIR RAPID RISE IN STOCK TURNOVER
SINCE 1993 FROM FOCUSING ON QUANTITATIVE INVESTING
4. THE HEDGE FUND QUANTITATIVE STRATEGIES SUCH AS STATISTICAL ARBITRAGE AND HIGH
FREQUENCY ALGORITHMIC TRADING (HFT) BECOME MORE POPULAR SINCE 1997 THAT SEEK TO
CAPTURE ANY PRICING SPREAD WITH DIFFERENTIAL BETWEEN ETFS AND INDEX FUNDS CAUSE
THE RESULT IN HIGHER SYSTEMATIC TRADING IN BASKET OF STOCKS SO OVERALL MARKET RISK
INCREASED VIA HIGHER PAIRWISE STOCK PRICE CORRELATION AND LOWER DISPERSION

16. FIGURE 5 : CROSS-SECTIONAL DISPERSION OF TRADING
VOLUME CHANGE FOR LARGE AND SMALL STOCKS
•DIFFERENCE BETWEEN LARGE CAP
(S&P500) AND SMALL CAP (NON S&P500),
BOTH OF TWO CAPITAL CAN REPRESENT IN
PASSIVE MANAGEMENT
•THE LARGE STOCKS HAVE HEAVIER INDEX
TRADING COMMONALITY COMPARE TO
SMALL STOCK

17. FIGURE 6 : AVERAGE PAIRWISE CORRELATION FOR PRICE
CHANGES AND VOLUME CHANGE FOR ALL STOCKS
• PRICE CHANGE AND VOLUME CHANE
MOVE IN THE SAME DIRECTION
• BOTH DAILY PRICE RETURN AND
TRADING VOLUME CHANGE HIGHLY
INCREASED AFTER 1997 WITH 2 REGIME
WITH FLAT FROM 1980-1996 AND
POSITIVE SLOPE IN 1997 ONWARD.

18. FIGURE 7 : AVERAGE PAIRWISE CORRELATION OF PRICE
CHANGES FOR S&P500 AND NON S&P500 STOCKS
• PASSIVE FUNDS ARE BENCHMARKED
AGAINST THE S&P500 WITH HIGHER
PAIRWISE EXPECTATION COMPARE TO
SMALL CAPITAL,
• BOTH CURVE OF RETURN CORRELATION OF
LARGE CAP AND SMALL CAP SHOW THE RISE
IN PASSIVE TRADING ON THE MARKET.
• THE T-STATISTIC REGRESSION APPLIED TO
PROVE ARE SIGNIFICANT
• SO MEANINGFUL RELATIONSHIP ON IMPACT
OF PASSIVE INVESTMENT IN THE MARKET.

19. FIGURE 8 : AVERAGE-CROSS CORRELATIONS BETWEEN TRADING VOLUME
LEVELS OR ABSOLUTE VOLUME CHANGES AND ABSOLUTE PRICE RETURN
• TO INVESTIGATE CROSS CORRELATION
BETWEEN PRICE RETURN AND TRADING
VOLUME FOUND THAT VOLUME CHANGE
• THE PRICE CHANGE BECAUSE INDEX TRADING
INVOLVE SYNCHRONIZED VOLUME CHANGE
ACROSS MANY STOCK
• REGRESSION WITH SIGNIFICANT TO SHOW
THE EXISTENCE OF RELATIONSHIP FROM T-
STATISTIC

20. FIGURE 9 : AVERAGE CROSS CORRELATION BETWEEN ABSOLUTE
VOLUME CHANGES AND ABSOLUTE PRICE CHANGES FOR S&P500
AND NON S&P500 STOCKS
• THE TIME SERIES CROSS CORRELATION
AMONG S&P500 AND NON S&P500
BETWEEN ABSOLUTE PRICE CHANGE AND
VOLUME CHANGE
• BOTH OF SMALL CAP AND LARGE CAP
MOVE HIGHER OVER TIME

21. IMPACT ON SYSTEMATIC RISK AND PORTFOLIO
DIVERSIFICATION
•THE RELATIONSHIP ON TRADING COMMONALITY DRIVEN BY PASSIVE INDEX TRADING BY REFER TO
THE RISE IN CORRELATION IN YIELD WITH AVERAGE BETAS.
•THE RESULT IN BETAS SHOWN THAT THE SMALL STOCK LESS SENSITIVE TO OVER MARKET RISK
COMPARE TO LARGE STOCK. FURTHERMORE, THE BETAS OF VALUE STOCK LOWER THAN GROWTH
STOCK DURING THE FIRST SUB PERIOD.
•THE INCREASED IN CONVERGENCE OF BETA SIGNIFICANTLY SUGGEST THAT IN THE SECOND
SUBPERIOD THE BENEFIT FROM DIVERSIFICATIONS WERE DROPPED WITH THE T-STATISTIC
SIGNIFICANT.

22. FIGURE 10 : EXCESS RETURN VOLATILITYAGAINST
NUMBER OF STOCKS
•IN THE SECOND SUBPERIOD
HAVE TO FACE THE
DIMINISHING IN ABILITY TO
DIVERSIFIED COMPARE TO
FIRST SUBPERIOD
• INVESTORS WHO WANT TO
MAINTAIN THE SAME EXCESS
RETURN NEED TO NUMBERS
OF STOCKS IN PORTFOLIO.
1st subperiod 2nd subperiod

23. ROBUSTNESS TEST AND FUTURE RESEARCH
•TO ENSURE THAT THE STOCK UNIVERSE IS MEANINGFULLY DIFFERENT RESULT ACROSS PERIOD
•BY RANDOMLY SELECT 500 STOCKS YIELD TO SHOW THE CONSISTENTLY RESULT TO UNDERSTAND
THE TREND AND BEHAVIOR OF INVESTORS IN INSTITUTION PART THAT CAN IMPACT TO MARKET
•THE RESULT SHOWN THAT STOCK WITHIN S&P500 HAVE HIGHER RETURN COMMONALITY AND
CORRELATION COMPARE TO NON S&P500 STOCKS
•FURTHER RESEARCH IS NEEDED TO BETTER DEVELOPMENT

24. CONCLUSION
• PASSIVE INVESTMENT IN INSTITUTION GAIN THE GROWTH AS THE TIME PAST AND BECOME THE MAIN
ACTIVITY OF TRADING.
• THE RISING IN PASSIVE INVESTING HAVE A CONNECTION WITH INCREASING IN MARKET SYSTEMATIC RISK
FROM THE INCREASING IN TRADING ACTIVITY ESPECIALLY ETFS
• THE LOWER ABILITY OF INVESTOR TO DIVERSIFIED THE RISK, TO INCREASE THE NUMBER OF HOLDING
STOCKS CAN HELP INVESTORS TO HAVE THE SAME EXCESS RETURN THE FURTHER RESEARCH IS VERY
CRUCIAL TO UNDERSTAND THE BEHAVIOR OF INVESTORS.
• THE DECLINE IN DIVERSIFICATION BENEFIT CAN COME UP WITH INCREASE IN MARKET VOLATILITY AND
INCREASE THE CHALLENGING IN RISK MANAGEMENT PORTFOLIO FROM HIGHER MARKET SYSTEMATIC RISK.

25. COMMENTS
•THE MORE ADDITIONAL PASSIVE MANAGED INVESTING COME IN THE MARKET CAUSE
TRADING TO HAVE HIGHER RISK .
•INVESTORS SHOULD TRY MORE TO UNDERSTAND THE MARKET AND INVESTORS
BEHAVIOR BECAUSE THE EFFECT OF MARKET EFFECTIVENESS CAUSE THE
INCREASING IN MARKET VOLATILITY
•TO LEARN MORE ABOUT THE ARBITRAGE STRATEGIES TO GAIN THE BENEFIT