Investment Noise and Trends
During the past few decades, the fraction of the equity market owned directly by individuals declined significantly. The same period witnessed investment trends that include the growth of indexing as well as shifts by active managers toward lower fees and more index-like investing. I develop an equilibrium model linking these investment trends to the decline in individual ownership, interpreting the latter as a reduction in noise trading. Active management corrects most noise-trader induced mispricing, and the fraction left uncorrected shrinks as noise traders' stake in the market declines. Less mispricing then dictates a smaller footprint for active management.
The author is grateful to Martijn Cremers, Rick Green, Ron Kaniel, Stijn Van Nieuwerburgh, Antti Petajisto, Nick Roussanov, Luke Taylor, and Yu Yuan for helpful comments or assistance. Special thanks go to Lubos Pastor for valuable comments and discussions. This paper was presented as the author's presidential address to the American Finance Association, Philadelphia, Pennsylvania, January 2014. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.