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> Everytime one of these articles comes up, someone says, "but who will do price discovery, this is terrible" Note that this has been around since 1980: > The

> Everytime one of these articles comes up, someone says, "but who will do price discovery, this is terrible" Note that this has been around since 1980: > The Grossman-Stiglitz Paradox is a paradox introduced by Sanford J. Grossman and Joseph Stiglitz in a joint publication in American Economic Review in 1980[1] that argues perfectly informationally efficient markets are an impossibility since, if prices perfectly reflected available information, there is no profit to gathering information, in which case there would be little reason to trade and markets would eventually collapse.[2] * https://en.wikipedia.org/wiki/Grossman-Stiglitz_Paradox https://en.wikipedia.org/wiki/Grossman-Stiglitz_Paradox Paper: * http://www.dklevine.com/archive/refs41908.pdf http://www.dklevine.com/archive/refs41908.pdf * https://papers.ssrn.com/sol3/papers.cfm?abstract_id=228054 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=228054 Price discovery happens at the edges: you probably don't need a lot activity for it. I think we're seeing a lot of the also-ran active managers (slowly) being weeded out, and the remainders will increasingly be those that actually manage to get things right every so often.

ItsMonkk 4y ago
This isn't taking into account that there is really no such thing as 'passive'. In reality, passive investors are constantly either investing with their paycheck, or selling in retirement. They are the world's simplest active investors. If you put money into passive then the index buys. If you request money, the index sells. So what you need to track is the net flows. If the net flows are positive, and there is so little active left in the market that no matter what the active investors do the stock still has positive net flows, then active has no other option than to buy. This eventually leads to stocks having an infinite price as there is no downward force. On the other hand, if net flows are negative, then prices go to 0.
- im3w1l 4y ago
  That's a passive failure mode I haven't seen before. To elaborate on what you said: Imagine an index, and an index fund tracking it. The index fund will own x% of every stock in the index. Someone buys the index fund, and the index fund now try to achieve x+epsilon% in every stock. But what if 100-x% of the stock is owned by diamond-hands hodlers, that wont sell at any price? The index fund bids higher and higher, and the sellers refuse to let their shares go, making the price reach ridiculous levels. The price reaching 0 seems less likely, as there will always be bargain hunters.
  - dsr_ 4y ago
    You're leaving out three factors: indexes are not static over long terms; the creation/destruction of new public corporations; and the possibility of existing public corporations offering more stock.
  - nradov 4y ago
    Index fund managers aren't idiots. Their trading systems still have a degree of sanity checking and human oversight, so they won't attempt to track the index exactly if things get weird. But for large-cap indexes like S&P 500, the "diamond-hands hodlers" lack the capital reserves necessary to really manipulate the market. At some point many of the underlying companies would also take advantage of excessive stock prices by issuing secondary offerings, thus increasing the supply.
    - lupire 4y ago
      Yah stock won't go to infinity. But TSLA joining the S&P 500 created synthetic demand that synthetically increased price/valuation.
  - HALtheWise 4y ago
    There's two key ways new stock can be created to avoid this risk: companies can issue it, or short sellers can create it. If the company sees its stock rising, it can and should see that as a cheap source of capital and absorb some of it through a stock sale to do more of whatever business they're in.
    - ItsMonkk 4y ago
      You think that companies are going to issue new stock in order to ensure that the value of their company doesn't go UP? If anything, the more they take out loans and buyback their stock, the faster it goes to infinity. And the faster it goes to infinity, the more collateral it has, to take out another loan, to buy more stock... And you think short-sellers are going to risk infinite losses? This is a prisoner's dilemma that you aren't going to win.
    - 4y ago
- skybrian 4y ago
  That’s an interesting way of looking at it, but it seems incomplete because for every buyer, there is a seller. A paycheck isn’t converted into stock, it’s traded for it, so some other account gets the cash. Supply and demand meant that asset prices went up, but that meant that the sellers got more cash for less stock. Who was selling? Recent retirees did well when they sold, but is there more to it than that? It’s an odd time when cash does poorly (inflation), bonds do worse, and the stock market fell. Prices are relative, though. I guess it’s all relative to commodities and labor. It seems like increased debt due to higher-priced assets as collateral probably needs to be taken into account too.
- throw0101a 4y ago
  > This isn't taking into account that there is really no such thing as 'passive'. In reality, passive investors are constantly either investing with their paycheck, or selling in retirement. They are the world's simplest active investors. If you put money into passive then the index buys. If you request money, the index sells. Passive investing means something, and what you are saying is not it. From William F. Sharpe, Nobel-winning economist who came up with capital asset pricing model (CAPM): > A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor's portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market[2]. * https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm A "passive" investment strategy is not about not-buying/selling, but rather about not actively choosing particular financial instruments. > Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio.[1][2] Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds.[3] * https://en.wikipedia.org/wiki/Passive_management https://en.wikipedia.org/wiki/Passive_management Following a particular index (NASDAQ, Dow Jones, S&P 500, Russell 3000, Wilshire 5000, TSX, FTSE 100, MSCI EAFE) is passive investing, even if you put in money every pay cheque.
  - jleahy 4y ago
    Technically speaking the Dow would not be a passive investment (by the definitions above), as it’s not market cap weighted.
    - lupire 4y ago
      Does anyone invest in a DoW index fund?
      - yareally 4y ago
        Yeah, people buy shares of DIA all the time. It's a popular index fund. Not as liquid as spx/spy/qqq, but it's still up there
Majromax 4y ago
> Note that this has been around since 1980: The strong efficient market hypothesis combined with completely rational (no-noise) market participants leads to a "no-trade theorem." If anyone tried to buy or sell a security based on new information, other market participants would incorporate that attempt into their information about the market. The notional price would change (bid/ask), but the security wouldn't trade hands. This is of course absurd in practice because securities do in fact trade, but it tells us that we don't need random retail investors picking stocks with coin flips (or asset managers doing so and charging 2%/yr for the privilege) in order to discover fair prices.

ItsMonkk 4y ago

This isn't taking into account that there is really no such thing as 'passive'. In reality, passive investors are constantly either investing with their paycheck, or selling in retirement. They are the world's simplest active investors. If you put money into passive then the index buys. If you request money, the index sells. So what you need to track is the net flows. If the net flows are positive, and there is so little active left in the market that no matter what the active investors do the stock still has positive net flows, then active has no other option than to buy. This eventually leads to stocks having an infinite price as there is no downward force. On the other hand, if net flows are negative, then prices go to 0.

im3w1l 4y ago
That's a passive failure mode I haven't seen before. To elaborate on what you said: Imagine an index, and an index fund tracking it. The index fund will own x% of every stock in the index. Someone buys the index fund, and the index fund now try to achieve x+epsilon% in every stock. But what if 100-x% of the stock is owned by diamond-hands hodlers, that wont sell at any price? The index fund bids higher and higher, and the sellers refuse to let their shares go, making the price reach ridiculous levels. The price reaching 0 seems less likely, as there will always be bargain hunters.
- dsr_ 4y ago
  You're leaving out three factors: indexes are not static over long terms; the creation/destruction of new public corporations; and the possibility of existing public corporations offering more stock.
- nradov 4y ago
  Index fund managers aren't idiots. Their trading systems still have a degree of sanity checking and human oversight, so they won't attempt to track the index exactly if things get weird. But for large-cap indexes like S&P 500, the "diamond-hands hodlers" lack the capital reserves necessary to really manipulate the market. At some point many of the underlying companies would also take advantage of excessive stock prices by issuing secondary offerings, thus increasing the supply.
  - lupire 4y ago
    Yah stock won't go to infinity. But TSLA joining the S&P 500 created synthetic demand that synthetically increased price/valuation.
- HALtheWise 4y ago
  There's two key ways new stock can be created to avoid this risk: companies can issue it, or short sellers can create it. If the company sees its stock rising, it can and should see that as a cheap source of capital and absorb some of it through a stock sale to do more of whatever business they're in.
  - ItsMonkk 4y ago
    You think that companies are going to issue new stock in order to ensure that the value of their company doesn't go UP? If anything, the more they take out loans and buyback their stock, the faster it goes to infinity. And the faster it goes to infinity, the more collateral it has, to take out another loan, to buy more stock... And you think short-sellers are going to risk infinite losses? This is a prisoner's dilemma that you aren't going to win.
  - 4y ago
skybrian 4y ago
That’s an interesting way of looking at it, but it seems incomplete because for every buyer, there is a seller. A paycheck isn’t converted into stock, it’s traded for it, so some other account gets the cash. Supply and demand meant that asset prices went up, but that meant that the sellers got more cash for less stock. Who was selling? Recent retirees did well when they sold, but is there more to it than that? It’s an odd time when cash does poorly (inflation), bonds do worse, and the stock market fell. Prices are relative, though. I guess it’s all relative to commodities and labor. It seems like increased debt due to higher-priced assets as collateral probably needs to be taken into account too.
throw0101a 4y ago
> This isn't taking into account that there is really no such thing as 'passive'. In reality, passive investors are constantly either investing with their paycheck, or selling in retirement. They are the world's simplest active investors. If you put money into passive then the index buys. If you request money, the index sells. Passive investing means something, and what you are saying is not it. From William F. Sharpe, Nobel-winning economist who came up with capital asset pricing model (CAPM): > A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor's portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market[2]. * https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm A "passive" investment strategy is not about not-buying/selling, but rather about not actively choosing particular financial instruments. > Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio.[1][2] Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds.[3] * https://en.wikipedia.org/wiki/Passive_management https://en.wikipedia.org/wiki/Passive_management Following a particular index (NASDAQ, Dow Jones, S&P 500, Russell 3000, Wilshire 5000, TSX, FTSE 100, MSCI EAFE) is passive investing, even if you put in money every pay cheque.
- jleahy 4y ago
  Technically speaking the Dow would not be a passive investment (by the definitions above), as it’s not market cap weighted.
  - lupire 4y ago
    Does anyone invest in a DoW index fund?
    - yareally 4y ago
      Yeah, people buy shares of DIA all the time. It's a popular index fund. Not as liquid as spx/spy/qqq, but it's still up there

Majromax 4y ago

> Note that this has been around since 1980: The strong efficient market hypothesis combined with completely rational (no-noise) market participants leads to a "no-trade theorem." If anyone tried to buy or sell a security based on new information, other market participants would incorporate that attempt into their information about the market. The notional price would change (bid/ask), but the security wouldn't trade hands. This is of course absurd in practice because securities do in fact trade, but it tells us that we don't need random retail investors picking stocks with coin flips (or asset managers doing so and charging 2%/yr for the privilege) in order to discover fair prices.