The Implications of Increased Passive Investment: A Theoretical Approach

Abstract: In this thesis, a theoretical model is constructed to assess potential implications of increased passive investment on capital market efficiency and stability. A population of active and passive investors is simulated in an artificial asset market to examine how the share of passive investment affects pricing efficiency, volatility, and comovement between assets. We find support for negative implications on total market valuation, between-asset valuations, and comovement, due to increased passive investment. Moreover, the findings suggest the impact of passive investment could suddenly grow exponentially when a certain threshold is reached. In light of this, we support the findings of previous literature that perceives the increase of passive investment as having a negative impact on market efficiency and stability.