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SS Privatization and Market Efficiencies
Old 02-10-2005, 05:33 PM   #1
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SS Privatization and Market Efficiencies

Perhaps right now this is just a bit more that a mute pondering, but I was wondering how SS privatization might affect market efficiencies. I picture large volumes of dollars automatically pouring into indexed equity and bond funds regardless of market performance. Would these be sufficient to buffer the effects of the "rational" investor in the ups and downs of market performance. I guess this is somewhat like what many indexed investors are doing now, but we are in a small enough minority that our effect is not significant. I guess in technical terms I see this as reducing the standard deviation of returns and shortening the time to return to the mean. Maybe there is more or less to this than I would think about?

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Re: SS Privatization and Market Efficiencies
Old 02-11-2005, 09:27 AM   #2
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Re: SS Privatization and Market Efficiencies

Perhaps right now this is just a bit more that a mute pondering, but I was wondering how SS privatization might affect market efficiencies.
This is something I've been thinking about, and will be giving more thought to. Note that it is impossible for 100% of shares of stocks to be invested in index funds.

But let's say 90% of all shares of all stocks were owned by index funds. That's 90% of the shares that won't sell if bad things happen to the stock, that won't buy on news of earnings, acquisitions, etc. That leaves 10% of the shares in the hands of people who are (or may be) paying attention to the stock. I think that's a good thing for people who buy individual stocks.

What happens, then, if the 10% of the stocks in the hands of non-index-funds want to hold on to their shares? The price will skyrocket, as very few want to sell (and the index funds *must* pay whatever the sellers are asking).

On the other hand, though, the same can occur on the downside (but to a lesser extent, since 90% of the shares won't be sold).

I would guess that the effects would be very similar to an illiquid stock (such as one with a low market cap). It's harder to judge the value of such stocks, they are more susceptible to pump-and-dump schemes, etc.

Of course, I doubt 90% of the shares of stocks would get purchased by index funds. There's a balance somewhere. But as index funds become more commonly used investment vehicles (either through SS, or advice of financial planners, or whatever), I'm sure it will have some noticeable effect on the markets.

Day traders could have fun with this, too. On a day with good news that lifts the market, bad stocks would be much more likely to rise in price, and with bad news that causes people to get out of their index funds, the price of good stocks would go down.

One of these days, I should check what percentage of the stock market is owned by various index funds.
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