Elephants in Equity Markets

We introduce a novel empirical market-clearing–based decomposition of equity price growth. Using sample holdings covering only an average of 6% of market capitalization, we account for, on average, 88% of time variation in over 22,000 individual stock prices and 95% of fluctuations in 33 aggregate stock indices. Changes in portfolio weights contribute most to the variance of individual stock prices, while “safe haven” markets feature strong cross-stock substitution patterns that leave aggregate portfolio weight changes uncorrelated with aggregate indices. Equity markets are global and exchange rates play a key equilibrating role. We find that the behavior of active funds’ portfolio managers has a causal effect on stock prices by transmitting firm-specific news. Similarly, final funds’ investors play a key role in transmitting macroeconomic and risk aversion news to stock prices.