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Passive Investment Strategies and Financial Bubbles

Fischer, Thomas (2012)
Passive Investment Strategies and Financial Bubbles.
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Item Type: Report
Type of entry: Primary publication
Title: Passive Investment Strategies and Financial Bubbles
Language: English
Date: 11 April 2012
Place of Publication: Darmstadt
Series: Darmstadt Discussion Papers in Economics
Series Volume: 212

In this paper, a model of bounded rational investors investing their portfolio in a passive investment vehicle (e.g., an Exchange Traded Fund replicating a broad index) or an actively managed fund is presented. The model proposes that the quick reswitching of these short-term oriented investors induces momentum behavior in prices. Investors prefer passsive funds in time of low risk-free rates and when active funds charge high management costs. Actively managed funds have a lower volatility but are only able to outperform the passive funds in downturns. Simulations confirm the emergence of two regimes: a regime where prices are close to fundamentals and another regime with a positive bubble. The size and the length of this bubble increases for low market liquidity and high switching speed of investors. The market volatility increases for strong reswitching activities and short-term thinking of bounded rational investors. Negative bubbles (market prices lower than fundamentals) tend to occur if active portfolio managers exhibit high risk aversion, but are less frequent than positive bubbles.

Uncontrolled Keywords: stock market - passive trading - financial stability - arbitrage trading - financial bubbles - Heterogeneous Agent Model
URN: urn:nbn:de:tuda-tuprints-47149
Additional Information:

JEL classification: G11 - C15 - C62 - D58

Classification DDC: 300 Social sciences > 330 Economics
Divisions: 01 Department of Law and Economics
01 Department of Law and Economics > Volkswirtschaftliche Fachgebiete
01 Department of Law and Economics > Volkswirtschaftliche Fachgebiete > Fachgebiet Makroökonomie und Finanzmärkte
Date Deposited: 14 Apr 2012 09:13
Last Modified: 26 Jan 2016 14:46
URI: https://tuprints.ulb.tu-darmstadt.de/id/eprint/4714
PPN: 377941727
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