I am an Assistant Professor of Finance at the Mendoza College of Business at the University of Notre Dame. I study Empirical Asset Pricing, Exchange-Traded Funds, Financial Market Design, High-Frequency Trading, and Market Microstructure. You can reach me at jshim2@nd.edu, and my CV is here.
Working Papers
Press: Bloomberg, Bloomberg (no paywall), Bloomberg Newsletter (no paywall), Rational Reminder Podcast (~35 min mark)
pAbstract: 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.
Abstract: We develop two new measures to quantify active fund decisions at the position level. Our measures are designed to separate flow-based passive scaling from active rebalancing decisions. We find that additive active rebalancing – both for existing and new positions – predicts higher stock-level alpha over the following quarter. We show our results are not driven by mechanical price pressure, and provide evidence that funds may trade on forecasts for future earnings. Finally, we aggregate our stock-level measure to the portfolio level and show that actively adding to positions translates to outsized returns for fund investors.
Press: Financial Times, Bloomberg, ETF.com
Abstract: Can ETFs trigger fire sales in illiquid assets? We develop and empirically examine a model where an authorized participant (AP) holds bond inventory and connects the ETF to the underlying bond market. For redemptions, the AP acts as a buffer between the two markets, holding redeemed bonds to preserve the mark-to-market value of her inventory and avoid a fire sale. For creations, the AP behaves asymmetrically, and transmits ETF purchases to the bond market to boost inventory mark-to-market values. The AP’s costs of handling creations/redemptions are paid by liquidity-demanding ETF investors via premiums/discounts. We document new empirical facts motivated by the model, and provide a novel explanation for why ETFs holding more liquid bonds traded at larger discounts than those holding illiquid bonds during the COVID-induced sell-off in March 2020. Our findings show that ETFs have advantages over mutual funds in managing illiquid assets.
Do Electronic Markets Improve Execution If You Cannot Identify Yourself?, with Yenan Wang, February 2023.
Abstract: We study the execution strategies of a large uninformed trader over the transition from human-based markets to electronic markets, focusing on two elements of this transition: (1) the increase in trading frequency, and (2) the loss of commitment power. We develop a multi-period model with symmetric information where an uninformed trader must liquidate her position to several market makers. A trader without commitment power is unambiguously better off from an increase in trading frequency. A trader that exchanges commitment power for more frequent trading is worse off. Commitment power is especially valuable if it can be coupled with frequent trading.
Abstract: I argue that arbitrage mistranslates factor information from ETFs to constituent securities and distorts comovement. The intuition behind this distortion is arbitrageurs trade constituent securities not based on their fundamental exposures but by their portfolio weights, causing securities to comove with the ETF based on a measure I call arbitrage sensitivity — a combination of portfolio weight and price impact sensitivity — rather than fundamental exposures. Arbitrage sensitivity predicts comovement between stock and ETF returns, especially in periods of high ETF volume and volatility, but not before 2008 when ETFs were not as heavily traded. Arbitrage-induced comovement leads to over-reaction to ETF returns for stocks more sensitive to arbitrage and under-reaction for those less sensitive. A long-short portfolio constructed based on arbitrage sensitivity generates an alpha of around 7.5% per year. Unlike most anomalies, arbitrage comovement is strongest in large-cap stocks, which are held by the most actively traded ETFs. Arbitrage comovement implies observed factor loadings are less reliable for assessing risk since they are at least partially driven by mechanical arbitrage trading instead of fundamental exposures.
Published Papers
A Theory of Stock Exchange Competition and Innovation: Will the Market Fix the Market?, with Eric Budish and Robin Lee. Journal of Political Economy, 2024.
Press: Bloomberg; Policy: SEC Commissioner, SEC Proposal on Market Data Infrastructure
Abstract: Will stock exchanges innovate to address latency arbitrage and the arms race for speed? This paper models how exchanges compete in the modern electronic era and how this shapes incentives for market design innovation. In the status quo, exchange trading fees are competitive while exchanges earn economic rents from selling speed. These rents create a wedge between private and social incentives to innovate, and support the persistence of an inefficient market design in equilibrium of a market design adoption game. We discuss implications for policy and insights for the literatures on market design, innovation, and platforms.
The High Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response, with Eric Budish and Peter Cramton. Quarterly Journal of Economics, 2015.
Press: Financial Times, Bloomberg, Chicago Tribune, Bloomberg Editorial Board, The Economist, Chicago Booth Review; Policy: SEC Chair, European Commission, New York Attorney General
Awards: AQR Insight Award (First Prize), Utah Winter Finance Conference (Best Paper Award)
Abstract: The high-frequency trading arms race is a symptom of flawed market design. Instead of the continuous limit order book market design that is currently predominant, we argue that financial exchanges should use frequent batch auctions: uniform price double auctions conducted, for example, every tenth of a second. That is, time should be treated as discrete instead of continuous, and orders should be processed in a batch auction instead of serially. Our argument has three parts. First, we use millisecond-level direct-feed data from exchanges to document a series of stylized facts about how the continuous market works at high-frequency time horizons: (i) correlations completely break down; which (ii) leads to obvious mechanical arbitrage opportunities; and (iii) competition has not affected the size or frequency of the arbitrage opportunities, it has only raised the bar for how fast one has to be to capture them. Second, we introduce a simple theory model which is motivated by and helps explain the empirical facts. The key insight is that obvious mechanical arbitrage opportunities, like those observed in the data, are built into the market design—continuous-time serialprocessing implies that even symmetrically observed public information creates arbitrage rents. These rents harm liquidity provision and induce a never-ending socially wasteful arms race for speed. Last, we show that frequent batch auctions directly address the flaws of the continuous limit order book. Discrete time reduces the value of tiny speed advantages, and the auction transforms competition on speed into competition on price. Consequently, frequent batch auctions eliminate the mechanical arbitrage rents, enhance liquidity for investors, and stop the high-frequency trading arms race.
Implementation Details for Frequent Batch Auctions: Slowing Down Markets to the Blink of an Eye, with Eric Budish and Peter Cramton. American Economic Review: Papers and Proceedings, 2014.
Work in Progress Papers
How do ETFs Manage Illiquid Assets? Evidence from Creation/Redemption Baskets, with Karamfil Todorov. (Develop novel methodology to infer creation/redemption baskets; results broken out from an early draft of "ETFs, Illiquid Assets, and Fire Sales.")
Speed Limits in Asset Prices, with Ben Matthies and Chen Wang.
The Arithmetic of Passive Management, with Marco Sammon.
Depth and Adverse Selection: Theory and Evidence, with Yenan Wang.