HYPOTHESIS OF THE ARTICLE

• THE RESEARCHER FOUND THAT PASSIVELY MANAGED INVESTMENT INCLUDED EQUITY MUTUAL

FUND AND EXCHANGE RATE (ETFS) HAVE INCREASED IN GROWTH TO REACH MORE THAN $1

TRILLION IN 2010.

• THE INCREASING IN THE POPULARITY OF THE INDEX TRADING LEAD TO HIGHER SYSTEMATIC RISK

IN THE MARKET, INCREASED IN CROSS-SECTIONAL TRADING COMMONALITY, AND HIGHER RETURN

CORRELATION AMONG STOCKS.

• THE MORE POPULARITY OF PASSIVE TRADING CAUSE THE BETA OF EQUITY TO INCREASE IN RECENT

YEAR DURING THE PERIOD OF STUDY.

• IN U.S. STOCK MARKET, THE RESEARCHER FOUND THAT THIS MARKET BECOME MORE VULNERABLE .

DATA COLLECTION

• COLLECT DATA FROM STOCKS THAT MEET CRITERIA ON NYSE, AMEX AND NASDAQ FROM 1 JANUARY

1979 TO 1 DECEMBER 2010

• BY LOOK AT THE DAILY RETURN AND DAILY EXCHANGE BASED ON TRADING VOLUME MONTHLY

MARKET CAPS, MONTHLY BOOK TO MARKET RATIOS AND NO. OF SHARE OUTSTANDING DIRECT

FROM MORNINGSTAR DATABASE.

• THE STUDY ALSO INCLUDE U.S EQUITY ETFS FUNDS AND U.S. MUTUAL FUND BOTH LIVE AND

DEFUNCT FUND.

FACTORS OF MARKET VULNERABLE

1. THE RISE OF SYSTEMATIC MARKET RISK (BETA)

2. THE INCREASED PORTION OF PASSIVE BASKET TRADING IN INDEX MUTUAL FUNDS AND ETFS

3. THE RISING IN MARKET EFFICIENCY

1. THE RISE OF SYSTEMATIC MARKET RISK (BETA)

• THE INCREASING OF INSTITUTIONAL OWNERSHIP CAUSE THE RISING IN SIZE, LIQUIDITY BETAS,

RETURN BETAS AND EFFICIENCY OF PRICE INFORMATION BUT INTRADAY VOLATILITY DECREASED.

2. THE RISING IN THE POPULATION OF PASSIVE MANAGED ASSETS • THE GROWTH OF INDEX MUTUAL FUND THAT OFFER LOW COST WITH VARIOUS SEGMENT OF

DIVERSIFICATION AND ETFS THAT ALLOW INTRADAY TRADING BASIS FOR ACTIVE MANAGED

INVESTMENT CAUSE THE INCREASING IN COST ON COMMONALITY STOCK TRADING FROM

CONTINUOUS BUYING AND SELLING LEAD TO THE UNWANTED AFFECTED ON THE MARKET.

3. THE RISING IN MARKET EFFICIENCY

•MARKET TEND TO BE MORE VOLATILE AND MORE EFFICIENT DUE TO THE PARTICIPANT REACT IN THE

SAME WAY WHEN UNANTICIPATED NEW INFORMATION AVAILABLE IN PUBLIC CAUSE THE LARGE

SWING IN IN MARKET PRICE.

FIGURE 1 : EQUAL WEIGHTED AVERAGE BATAS FOR U.S. STOCKS BY SIZE AND STYLE

• THE RISE IN SYSTEMATIC RISK

RELATED TO THE RISE IN POPULARITY

OF PASSIVE MANAGED INDEX FUND

• INCREASING IN COMMONALITY

TRADING STOCKS THAT CAUSE THE

IMPACT ON SYSTEMATIC MARKET

RISK.

• INDEX INVESTING DISTORT THE

STOCK PRICE AND RISK RETURN

TRADE OFF

THE GROWTH OF INDEX TRADING

• THE EQUITY SHARES HOLD BY THE INSTITUTION INCREASED FROM 24 PERCENT IN 1980 TO 44 PERCENT IN 2000 AND

REACH 70 PERCENT IN 2010.

YEAR 1980 : 24% > YEAR 2000 : 44% > YEAR 2010 : 70%

• THE AVERAGE NUMBER OF INSTITUTION HOLDING TYPICAL FIRM SHARES IN NYSE GROWN FROM 54 INSTITUTIONS IN

1980 TO 125 IN 2000 AND REACH TO 405 IN 2010. THE NYSE MAIN TRADING ACTIVITIES BELONG TO INSTITUTIONAL

TRADING ACCOUNT OVER 70 PERCENT OF TRADING VOLUME.

YEAR 1980 : 54 > YEAR 2000 : 125 > YEAR 2010 : 405

FIGURE 2 : GROWTH IN EQUITY FUND ASSETS BY TYPE OF FUND• PANEL A : TOTAL DOLLAR GROWTH

• PASSIVE MANAGED INVESTMENT

AS INDEX MUTUAL FUND PLUS ETFS

HAVE REACHED $3.5 TRILLION IN

OCTOBER 2010

FIGURE 2 : GROWTH IN EQUITY FUND ASSETS BY TYPE OF FUND• PANEL B : FUND TYPE BY PERCENT OF TOTAL ASSETS

• THE PASSIVE FUND INCREASED

MARKET SHARE AGAINST ACTIVE

FUND OVER THE LAST TWO

DECADES

THE VANGUARD 500 INDEX (VFIAX)

• THE VANGUARD 500 INDEX (VFIAX) CAN HELP RESEARCHERS TO UNDERSTAND THE POTENTIAL

IMPACT OF INDEX

• THE REASON IS THE COMPANY TRADING ON THE MARKET AS ONE OF THE LARGEST INDEX MUTUAL

FUND THAT HAS ABOUT $106 BILLION ASSET AND HOLD AROUND 500 STOCKS

• THE TRADING ACTIVITY FROM THIS MUTUAL FUND REPRESENT 400 PERCENT OF TYPICAL DAILY

VOLUME THAT STOCK.

FIGURE 3 : ETFS SHARE OF TOTAL U.S. TRADE VOLUMEMARCH 2000 – SEPT 2011

• ETFS SHARE OF U.S. TRADE VOLUME

RISE FROM 2000 UNTIL NOW,

• TRADING VOLUME INCREASED ABOUT

30 PERCENT OF TOTAL DOLLAR AND

INCREASED 20 PERCENT OF TOTAL

SHARE VOLUME.

• ETFS BECOME THE KEY INSTRUMENT

FOR INVESTOR TO NOTIFY IMPACT ON

THE MARKET IN TRADE VOLUME AND

MARKET PRICE.

MEASURING TRADING COMMONALITY

• INDEX FUND THAT INCLUDE BOTH ETFS AND MUTUAL FUNDS BUY AND SELL GROUPS OF STOCKS

VIA BASKET THAT RESPONSE TO THE CAPITAL INFLOW AND OUTFLOW TO IMPACT IN PRICE IN

DIFFERENT SPREAD TIME.

• THE INDEX MANAGER ATTEMPTS TO MITIGATE THE MARKET IMPACT BY SPREADING REQUIRED

ORDER FLOW OVER TIME.

• THE IMPACT OF CROSS-SECTIONAL DISPERSION OF TRADING VOLUME ON MARKET ACTIVITY BY

CALCULATING THE DERIVATION OF VCT AS MEASURED ACROSS ALL STOCK AT EACH TIME PERIOD

(T)

• THE EQUATION VCT = LN [ V(T) / V(T-1) ].

FIGURE 4 : CROSS-SECTIONAL DISPERSION OF TRADING VOLUME CHANGE VS GROWTH OF PASSIVE ASSETS

• THE RESULT SHOWN THAT THERE ARE

2 PART

• FIRST PART IN FLAT GRAPH FROM

1997 TO 1996 AND DECLINE IN

SECOND PART AT ALMOST CONSTANT

RATE.

• AT SECOND REGIME INDEX

INVESTMENT BEGAN POPULARITY BY

ETFS TRADE ACTIVITY, AS THE

INCREASE IN INDEX TRADING DRIVES

HIGHER RETURN COVARIANCE IN

CONSTITUENT STOCKS.

THE SOURCES OF PHENOMENON

1. FROM OVERALL GROWTH IN INSTITUTIONAL ASSET

2. THE ACTIVE MUTUAL FUNDS THAT MANAGED AGAINST AN INDEX BENCHMARK AND CONTRIBUTE

TO THE INCREASED IN SYSTEMATIC MARKET RISK.

3. THE RISE OF INSTITUTIONAL INVESTOR THAT SHOWN THEIR RAPID RISE IN STOCK TURNOVER

SINCE 1993 FROM FOCUSING ON QUANTITATIVE INVESTING

4. THE HEDGE FUND QUANTITATIVE STRATEGIES SUCH AS STATISTICAL ARBITRAGE AND HIGH

FREQUENCY ALGORITHMIC TRADING (HFT) BECOME MORE POPULAR SINCE 1997 THAT SEEK TO

CAPTURE ANY PRICING SPREAD WITH DIFFERENTIAL BETWEEN ETFS AND INDEX FUNDS CAUSE

THE RESULT IN HIGHER SYSTEMATIC TRADING IN BASKET OF STOCKS SO OVERALL MARKET RISK

INCREASED VIA HIGHER PAIRWISE STOCK PRICE CORRELATION AND LOWER DISPERSION

FIGURE 5 : CROSS-SECTIONAL DISPERSION OF TRADING VOLUME CHANGE FOR LARGE AND SMALL STOCKS

• DIFFERENCE BETWEEN LARGE CAP

(S&P500) AND SMALL CAP (NON S&P500),

BOTH OF TWO CAPITAL CAN REPRESENT IN

PASSIVE MANAGEMENT

• THE LARGE STOCKS HAVE HEAVIER INDEX

TRADING COMMONALITY COMPARE TO

SMALL STOCK

FIGURE 6 : AVERAGE PAIRWISE CORRELATION FOR PRICE CHANGES AND VOLUME CHANGE FOR ALL STOCKS

• PRICE CHANGE AND VOLUME CHANE

MOVE IN THE SAME DIRECTION

• BOTH DAILY PRICE RETURN AND

TRADING VOLUME CHANGE HIGHLY

INCREASED AFTER 1997 WITH 2 REGIME

WITH FLAT FROM 1980-1996 AND

POSITIVE SLOPE IN 1997 ONWARD.

FIGURE 7 : AVERAGE PAIRWISE CORRELATION OF PRICE CHANGES FOR S&P500 AND NON S&P500 STOCKS

• PASSIVE FUNDS ARE BENCHMARKED

AGAINST THE S&P500 WITH HIGHER

PAIRWISE EXPECTATION COMPARE TO

SMALL CAPITAL,

• BOTH CURVE OF RETURN CORRELATION OF

LARGE CAP AND SMALL CAP SHOW THE RISE

IN PASSIVE TRADING ON THE MARKET.

• THE T-STATISTIC REGRESSION APPLIED TO

PROVE ARE SIGNIFICANT

• SO MEANINGFUL RELATIONSHIP ON IMPACT

OF PASSIVE INVESTMENT IN THE MARKET.

FIGURE 8 : AVERAGE-CROSS CORRELATIONS BETWEEN TRADING VOLUME LEVELS OR ABSOLUTE VOLUME CHANGES AND ABSOLUTE PRICE RETURN

• TO INVESTIGATE CROSS CORRELATION

BETWEEN PRICE RETURN AND TRADING

VOLUME FOUND THAT VOLUME CHANGE

• THE PRICE CHANGE BECAUSE INDEX TRADING

INVOLVE SYNCHRONIZED VOLUME CHANGE

ACROSS MANY STOCK

• REGRESSION WITH SIGNIFICANT TO SHOW

THE EXISTENCE OF RELATIONSHIP FROM T-

STATISTIC

FIGURE 9 : AVERAGE CROSS CORRELATION BETWEEN ABSOLUTE VOLUME CHANGES AND ABSOLUTE PRICE CHANGES FOR S&P500 AND NON S&P500 STOCKS

• THE TIME SERIES CROSS CORRELATION

AMONG S&P500 AND NON S&P500

BETWEEN ABSOLUTE PRICE CHANGE AND

VOLUME CHANGE

• BOTH OF SMALL CAP AND LARGE CAP

MOVE HIGHER OVER TIME

IMPACT ON SYSTEMATIC RISK AND PORTFOLIO DIVERSIFICATION• THE RELATIONSHIP ON TRADING COMMONALITY DRIVEN BY PASSIVE INDEX TRADING BY REFER TO

THE RISE IN CORRELATION IN YIELD WITH AVERAGE BETAS.

• THE RESULT IN BETAS SHOWN THAT THE SMALL STOCK LESS SENSITIVE TO OVER MARKET RISK

COMPARE TO LARGE STOCK. FURTHERMORE, THE BETAS OF VALUE STOCK LOWER THAN GROWTH

STOCK DURING THE FIRST SUB PERIOD.

• THE INCREASED IN CONVERGENCE OF BETA SIGNIFICANTLY SUGGEST THAT IN THE SECOND

SUBPERIOD THE BENEFIT FROM DIVERSIFICATIONS WERE DROPPED WITH THE T-STATISTIC

SIGNIFICANT.

FIGURE 10 : EXCESS RETURN VOLATILITYAGAINSTNUMBER OF STOCKS

• IN THE SECOND SUBPERIOD

HAVE TO FACE THE

DIMINISHING IN ABILITY TO

DIVERSIFIED COMPARE TO

FIRST SUBPERIOD

• INVESTORS WHO WANT TO

MAINTAIN THE SAME EXCESS

RETURN NEED TO NUMBERS

OF STOCKS IN PORTFOLIO.

1st subperiod 2nd subperiod

ROBUSTNESS TEST AND FUTURE RESEARCH

• TO ENSURE THAT THE STOCK UNIVERSE IS MEANINGFULLY DIFFERENT RESULT ACROSS PERIOD

• BY RANDOMLY SELECT 500 STOCKS YIELD TO SHOW THE CONSISTENTLY RESULT TO UNDERSTAND

THE TREND AND BEHAVIOR OF INVESTORS IN INSTITUTION PART THAT CAN IMPACT TO MARKET

• THE RESULT SHOWN THAT STOCK WITHIN S&P500 HAVE HIGHER RETURN COMMONALITY AND

CORRELATION COMPARE TO NON S&P500 STOCKS

• FURTHER RESEARCH IS NEEDED TO BETTER DEVELOPMENT

CONCLUSION

• PASSIVE INVESTMENT IN INSTITUTION GAIN THE GROWTH AS THE TIME PAST AND BECOME THE MAIN

ACTIVITY OF TRADING.

• THE RISING IN PASSIVE INVESTING HAVE A CONNECTION WITH INCREASING IN MARKET SYSTEMATIC RISK

FROM THE INCREASING IN TRADING ACTIVITY ESPECIALLY ETFS

• THE LOWER ABILITY OF INVESTOR TO DIVERSIFIED THE RISK, TO INCREASE THE NUMBER OF HOLDING

STOCKS CAN HELP INVESTORS TO HAVE THE SAME EXCESS RETURN THE FURTHER RESEARCH IS VERY

CRUCIAL TO UNDERSTAND THE BEHAVIOR OF INVESTORS.

• THE DECLINE IN DIVERSIFICATION BENEFIT CAN COME UP WITH INCREASE IN MARKET VOLATILITY AND

INCREASE THE CHALLENGING IN RISK MANAGEMENT PORTFOLIO FROM HIGHER MARKET SYSTEMATIC RISK.

COMMENTS

•THE MORE ADDITIONAL PASSIVE MANAGED INVESTING COME IN THE MARKET CAUSE

TRADING TO HAVE HIGHER RISK .

•INVESTORS SHOULD TRY MORE TO UNDERSTAND THE MARKET AND INVESTORS

BEHAVIOR BECAUSE THE EFFECT OF MARKET EFFECTIVENESS CAUSE THE

INCREASING IN MARKET VOLATILITY

•TO LEARN MORE ABOUT THE ARBITRAGE STRATEGIES TO GAIN THE BENEFIT