The growth of passive investing has stimulated academic and policy interest in how it affects asset prices and the real economy.

Hao Jiang, Dimitri Vayanos and Lu Zheng, authors of the March 2025 paper Passive Investing and the Rise of Mega-Firms, set out to understand how the increasing shift from active to passive investing influences asset prices, particularly the prices of the largest firms in the market. They developed a theoretical model showing how the rise of passive investing should affect prices in market equilibrium. They also tested some of the predictions of the model in the data by analyzing the effects of capital flows into passive funds (such as index funds and exchange-traded funds) on the stock prices and volatility of large-cap companies. Their data sample took the S&P 500 and flows into index mutual funds and index ETFs tracking it. It covered the period from 1996 to 2020.

Before digging into their findings, we need to discuss two key points. Fi