Market ecology of active and passive investors

Abstract

We study the role of active and passive investors in an investment market with uncertainties. Active investors concentrate on a single or a few stocks with a given probability of determining the quality of them. Passive investors spread their investment uniformly, resembling buying the market index. In this toy market stocks are introduced as good and bad. If a stock receives sufficient investment it will survive, otherwise die. Active players exert a selective pressure since they can determine to an extent the investment quality. We show that the active players provide the driving force whereas the passive ones act as free riders. While their gains do not differ too much, we show that the active players enjoy an edge. Their presence also provides better gains to the passive players and stocks themselves.