The Rational Reminder Podcast
Episode 314 - Professor Valentin Haddad: How Competitive is the Stock Market?
Episode guests
Podcast summary created with Snipd AI
Quick takeaways
- Passive investing affects market liquidity and investor reactions to price changes.
- Market bubbles can arise from flows into index funds and innovation, influencing asset prices.
- Individual investors should adopt balanced strategies amidst changing market dynamics.
- Market bubbles lead to excessive valuation of innovation, impacting competitors and market stability.
Deep dives
Shift towards Passive Investing and Market Elasticity
The podcast discusses the significant shift towards passive investing over the last 20 years, highlighting that approximately 40% of the market is now passive. It delves into the concept of demand elasticity in relation to passive investing, explaining that when investors become passive, they decrease the liquidity shock trading they provide to markets. This shift affects how investors react to price changes and strategic interactions in the financial markets.
Implications on Asset Prices and Market Stability
The episode explores how the rise of passive investing influences asset prices and market volatility. It suggests that as more investors become passive, markets may experience greater sensitivity to trading activity and price changes, potentially leading to increased volatility. The discussion also touches upon the potential impact on market stability and how strategic responses among investors play a role in maintaining equilibrium in asset prices.
Bubbles, Innovation, and Regulatory Frameworks
The podcast delves into the relationship between bubbles, innovation, and regulatory interventions in the financial markets. It considers the potential formation of bubbles in large stocks due to flows into index funds and the implications for market dynamics. The conversation extends to the challenges in defining bubbles and measuring the value of innovation, highlighting the importance of monitoring market trends and regulatory responses to ensure financial stability.
Strategy for Investors and Value of Innovation
The episode provides insights into the strategies individual investors can adopt in response to the changing landscape of passive investing and market dynamics. It discusses the potential opportunities for informed investors and the necessity for a balanced approach to investing. Furthermore, it examines measuring the value of innovation by considering the consequences of innovative advancements and the impact on market profitability.
The Concept of Bubbles and Defining Innovation
The podcast deep dives into the concept of bubbles within financial markets and how innovation can influence market dynamics. It defines bubbles based on significant price run-ups and increased trading volumes in specific industry portfolios. Moreover, the episode explores the challenges in measuring the value of innovation and the complexities associated with assessing the impact of innovative developments on market profitability and sector growth.
Market Value of Innovation During Bubbles
During periods of market bubbles, the market values innovation more excessively. The paper investigates how much price change occurs after the release of an innovation, revealing exaggerated reactions in the market. While positive responses to patents are common, the market tends to overvalue innovations, resulting in larger price increases than justified by subsequent performance. Competitors of innovative firms usually suffer as a consequence, with stock prices dropping and sales/profits declining.
Fed's Intervention in Corporate Bond Market During Crisis
The Federal Reserve's intervention in the corporate bond market during the 2020 pandemic crisis marked a significant departure from traditional practices. While the Fed initially announced plans to buy up to $800 billion in investment-grade corporate bonds, the actual intervention was limited, with only around $14 billion in assets purchased. This unprecedented move raised concerns regarding future market stability and the potential moral hazards associated with central bank interventions.
In this episode, we sit down with Professor Valentin Haddad to unpack the intricacies of market elasticity, passive investing, and the dynamic nature of financial markets. Valentin is an Associate Professor of Finance at UCLA Anderson School of Management and a research fellow for the National Bureau of Economic Research’s Asset Pricing Program. His research focuses on how financial institutions trade, and manage risk, and their impact on market prices and the broader economy. Notably, his work challenges traditional assumptions, such as the perceived safety of life insurance companies' investments in Treasuries. In our conversation, we delve into the impact of index funds on the market, stock market bubbles around the development of new technology, and the response of investment-grade corporate bonds to the COVID-19 crisis. Discover the definition of demand elasticity, strategic interaction, and how market elasticity has changed over time. Explore how he defines a market bubble, ways stock market bubbles are related to new technology, and how to measure the value of innovation. We also discuss the impact of COVID-19 on investment-grade corporate bonds, the Federal Reserve’s response, the implications for bond safety, and much more. Tune in and join us as we uncover the mess of the market with Professor Valentin Haddad!
Key Points From This Episode:
(0:03:10) The impact of passive investing on financial markets, what investors’ demand elasticity is, and the role of index funds.
(0:06:07) Learn about strategic interactions, their influence on financial markets, and how they react to rising passive investing.
(0:10:10) Why active investors’ options are limited in a passive investment landscape and how demand elasticities influence asset prices.
(0:13:05) How individual investor elasticities are related to aggregate market elasticity and the ways investor elasticity has changed.
(0:20:54) Large and small stock elasticity trends, the implications of his research for asset prices, and the relationship between elasticity and information.
(0:25:32) His opinion on a bubble in large stocks forming due to flows into index funds and how market bubbles drive innovation.
(0:29:31) Potential measures to address the issues with index funds and how individual investors should be reacting to the situation.
(0:34:46) Unpack how he defines a market bubble, measuring the value of innovation, and their effect on the value of technology.
(0:42:29) What his research findings mean for innovation policy and what to consider before investing in innovative companies.
(0:46:33) Insights from his paper examing the impact of COVID-19 on fixed-income and the different market reactions.
(0:53:40) Explore the Fed’s intervention during the pandemic, what effect it had, and the safety that bonds offer during a crisis.
Quotes:
“You choose how you trade based on how other people are trading. So, it's not really just what you like to do, but how you react to others in the market.” — Professor Valentin Haddad (0:06:40)
“If nobody's acquiring information, then markets are very inefficient. Then, you should step in, in a way. So, if everybody is becoming passive, there are more gains for being not passive.” — Professor Valentin Haddad (0:22:59)
“Speculation often comes with innovation.” — Professor Valentin Haddad (0:28:30)
“I think these concerns with passive investing are meaningful. I don't think it's quite yet the time for a very strong regulatory call. Regulators should keep track of this evolution.” — Professor Valentin Haddad (0:31:42)
“You can gain from bubbles, but at the end, the end of the bubble comes. The long-term gains of innovation are still there, but many people who partake in the bubble are going to suffer a lot.” — Professor Valentin Haddad (0:43:57)
Links From Today’s Episode:
Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582. Rational Reminder Website — https://rationalreminder.ca/
Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/
Rational Reminder on X — https://x.com/RationalRemind
Rational Reminder on YouTube — https://www.youtube.com/channel/
Rational Reminder Email — info@rationalreminder.caBenjamin Felix — https://www.pwlcapital.com/author/benjamin-felix/
Benjamin on X — https://x.com/benjaminwfelix
Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/
Cameron Passmore — https://www.pwlcapital.com/profile/cameron-passmore/
Cameron on X — https://x.com/CameronPassmore
Cameron on LinkedIn — https://www.linkedin.com/in/cameronpassmore/
Professor Valentin Haddad — https://sites.google.com/site/valentinhaddadresearch/
Professor Valentin Haddad on LinkedIn — https://www.linkedin.com/in/valentin-haddad-0056843/
Professor Valentin Haddad Email — valentin.haddad@anderson.ucla.edu
UCLA Anderson School of Management — https://www.anderson.ucla.edu/
National Bureau of Economic Research (NBER) — https://www.nber.org/
Episode 212: Prof. Ralph Koijen — https://rationalreminder.ca/podcast/212
Papers From Today’s Episode:
‘How Competitive is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing’ — https://dx.doi.org/10.2139/ssrn.3821263
‘Concentrated Ownership and Equilibrium Asset Prices’ — https://www.stern.nyu.edu/sites/default/files/assets/documents/Princeton- Haddad - Concentrated ownership.pdf
‘Bubbles and the Value of Innovation’ — https://drive.google.com/file/d/1tnvZ5L_zUcehn5hR720Nl1vtsTv4VgK0/view
‘When selling becomes viral: Disruptions in debt markets in the COVID-19 crisis and the Fed’s response’ — https://doi.org/10.1093/rfs/hhaa145
‘How Speculation Affects the Market and Outcome-Based Values of Innovation’ — https://ideas.repec.org/a/fip/fedreb/94686.html
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