DP14843 More Risk, More Information: How Passive Ownership Can Improve Informational Efficiency

Author(s): Adrian Buss, Savitar Sundaresan
Publication Date: June 2020
Keyword(s): asset allocation, Asset Pricing, Informational efficiency, passive investing, Risk Taking
JEL(s): G11, G14, G23
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14843

We identify a novel economic mechanism through which passive ownership positively affects informational efficiency in the cross-section of firms. Passive ownership lowers the cost of capital, encouraging firms to invest more aggressively in risky growth opportunities. The resultant higher cash flow volatility induces active investors to acquire more information, implying higher price informativeness for firms with high passive ownership. These firms also have higher stock prices and higher stock-return variances. In aggregate, a rise in passive ownership can also improve informational efficiency if uninformed investors are crowded out. We document that our mechanism applies more generally to benchmarked institutional investors.