ERBE 03 1 03
Are Passive Exchange-Traded Funds a Catalyst for Market Instability?
CARLOS ALVES 
a; DIOGO GOMES b
a Faculdade de Economia, University of Porto and Center for Economics and Finance (CEF-UP), Porto, Portugal, b Faculdade de Economia, University of Porto, Porto, Portugal.
To cite this article:
Alves, Carlos, Diogo Gomes. 2023. Are Passive Exchange-Traded Funds a Catalyst for Market Instability?, European Review of Business Economics III(1): 43-64.
DOI: https://doi.org/10.26619/ERBE-2023.3.1.3
Received: 28 December 2023. Accepted: 17 February 2024. Published: 21 March 2024.
Language: English
Abstract
Exchange-traded funds (ETFs) figure prominently as a notable outcome of financial innovation, offering a cost-efficient avenue for acquiring a diversified portfolio and enabling frequent trading. However, the significant expansion of the ETF market has raised concerns among investors and regulators. The heightened liquidity and passive characteristics of indexed ETFs have the potential to lead to synchronized movements in stock prices and noise trading, thereby impacting underlying securities through arbitrage. They can also affect investors’ portfolio choices in ways that can induce contagion across them. This research examines the influence of the escalating ownership of passive ETFs on U.S. stocks and its potential to destabilize the market. Utilizing the constituents of the S&P 500 index, our findings supported the pivotal role of passive ETF ownership in shaping price volatility and systematic risk. Moreover, the study reveals compelling evidence suggesting that issuer concentration in the underlying index may act as an additional factor contributing to systematic risk.
Keywords
ETF; Exchange-Traded Funds; Passive Investment; Volatility; Systematic Risk.
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