Working Paper: NBER ID: w18944
Authors: John H. Cochrane
Abstract: I address the controversy over whether the financial services industry is "too big." We should be asking whether the finance industry is functioning properly instead. The facts suggest that demand for financial services increased, perhaps temporarily, rather than suggesting a changing distortion within the industry. The puzzling persistence of actively managed mutual funds is finally yielding to supply and demand analysis, but the increasing preference for high-fee delegated management by sophisticated institutional investors remains somewhat of a puzzle. Conventional alpha-beta analysis does not capture the rich structure of risk premiums, which active management may be accessing. High-frequency information trading and the price-discovery process remain a puzzle as well. Many "inefficiencies" and events of the financial crisis suggest too little rather than too much active trading. The instability and regulation of the US financial system are more important issues than its mere size.
Keywords: finance; active management; market efficiency; financial regulation
JEL Codes: G0; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in demand for financial services (G20) | increase in fees for financial services (G20) |
| increase in demand for financial services (G20) | persistence of high-fee active management by sophisticated investors (G41) |
| complexity of financial products and services (G20) | consumer behavior (D19) |
| market structure (D49) | consumer behavior (D19) |
| finance industry's size (G20) | finance industry's ability to function effectively (G28) |