Research

Equity markets are now largely dominated by passive investments. This study introduces the Indexing Inclusion Ratio (IXI) as a measure of passive ownership to assess its increasing impact on U.S. equity markets. The findings reveal that high-indexed stocks highly outperform their low-indexed counterparts, primarily due to the influx of passive capital flows rather than fundamental value. By analyzing the expected return both ex-ante through implied costs of capital and ex-post by adjusting for passive flows and earnings anomalies, I show that high-indexed stocks exhibit lower expected returns, indicating a potential correction when the trend toward passive investing reaches equilibrium. In addition, I show that the recent underperformance of value and small-cap stocks is intrinsically related to the secular passive shift.

We develop a demand-system asset pricing model in which investors differ both in beliefs about climate-adjusted returns and in perceived exposure to nontradable climate background risk. The belief channel operates through subjective expected returns. The hedging channel generates portfolio demand for climate insurance that does not respond to prices within the static model. In equilibrium, this hedging motive adds a third term to the brown-minus-green return spread beyond market risk and belief differences. The model's most distinctive prediction is cross-sectional: stocks with larger absolute climate correlation become more dominated by hedging demand, whether they are green or brown. A quantitative illustration shows that the mechanism produces plausible shifts in return spreads and demand composition under illustrative parameterizations.