Press: Bloomberg, Bloomberg (no paywall), Bloomberg Newsletter (no paywall), Rational Reminder Podcast (~35 min mark), The Economist
Awards: 2025 ASU Sonoran Winter Finance Conference, Jacob Gold & Associates Best Paper Prize
Abstract: Each time a stock is bought or sold by a passive index fund, who takes the other side? We use quarterly holdings, transactions and shares outstanding data from 2002 to 2021 to form 10 mutually exclusive groups, including index funds, active mutual funds, large financial institutions, insiders, short sellers, and firms. We combine a simple regression framework with a market clearing condition to assess who tends to take the other side of trades by passive vehicles. Over the past 20 years across all stocks, firms are the largest providers of shares to passive investors on average and on the margin: For every 1 percentage point (pp) change in ownership by index funds, firms take the other side at a rate of 0.64 pp. When restricting to stock-quarters where index funds are net buyers, firms issue at a rate of 0.95 pp. We construct an instrument to isolate inelastic index fund demand, which supports our estimated magnitudes, and helps rule out alternative explanations. Our IV suggests that firms, through adjustments in the supply of shares, are the single-most responsive group to inelastic demand. More than half of the adjustment comes through stock compensation, stock options, and restricted stock units, which is consistent with greater supply responsiveness for index fund purchases versus sales. We estimate a firm supply elasticity of 1.49. Our analysis suggests that price impact multipliers are smaller and/or demand curves are steeper (and may even be upward sloping) than estimates from the literature, which assumes supply is perfectly inelastic.