Passive investing and the two faces of market efficiency: evidence from ETF markets and earnings announcements

Details

Supervisors

Iania, Leonardo

Faculty

Louvain School of Management

Degree label

Master [120] : ingénieur de gestion, à finalité spécialisée

Abstract

enThis thesis examines whether the rise of passive investing affects market efficiency in two distinct dimensions: aggregate market functioning and firm-level price discovery. The analysis is organized in two empirical stages. First, using daily data for major equity ETFs and benchmark indices in the United States and the Euro Area, the thesis tests whether passive flows are associated with changes in volatility, liquidity, benchmark synchronization, and ETF pricing efficiency. Second, it studies allocative efficiency through an announcement-day cross-sectional price-discovery test on S&P 500 firms, comparing the association of stock returns with a firm-level earnings-related proxy and with a stock-level proxy for benchmark-linked passive pressure. The macro-level results do not provide robust evidence that daily passive flows destabilize large ETF markets through higher volatility, weaker liquidity, or stronger synchronization. Instead, the evidence suggests that the ETF trading ecosystem remains broadly resilient, while ETF pricing deviations are more tightly linked to market conditions and limits to arbitrage than to passive flows alone. At the micro level, the unconditional baseline shows a strong association between announcement-day returns and benchmark-linked passive pressure. However, this association does not survive standard endogeneity tests that absorb the common market component embedded in the regressor through the firm's benchmark weight, while the earnings-related signal remains stable and significant across all specifications, including the most demanding ones. Overall, the findings support a nuanced conclusion. In the large-cap, short-horizon setting studied here, passive investing is not associated with a generalized breakdown in market plumbing, and firm-level price discovery continues to respond robustly to firm-specific earnings-related signals. The apparent dominance of benchmark-linked pressure observed in the unconditional baseline is largely traceable to a mechanical market-beta channel embedded in the construction of the proxy, rather than to an independent demand effect. Passive investing should therefore be viewed neither as harmless by construction nor as destabilizing in the empirical setting studied; the deeper concerns raised by the broader literature on informational efficiency are likely to operate over longer horizons and through channels that a single announcement-day cross-section cannot fully capture.