I recent had an interesting conversation with Zach Mazlish. We were trying to make sense of the following two papers:
HHL: “The rise in passive
investing over the last 20 years has made the demand for individual stocks 11% more inelastic.”
FIM: AQR Capital’s trading costs (which are dominated by the short-term elasticity of market makers) have generally decreased over the last two decades.
These seem to have opposing implications for the change over time in the elasticity of the stock market with respect to a random flow shock.
One way to reconcile this discrepancy is to suppose that the shape of the shock matters. Maybe the market is more willing to provide to short sharp flows, and less willing to provide to slow steady flows. The decline in active management and rise in systematic trend following behavior may have contributed to such a shift. This theory is not very predictive, because it’s practically difficult to measure exogenous long-term impact.