TAILIEUCHUNG - IS STOCK PICKING DECLINING AROUND THE WORLD?*

To assess the explanatory power of a trust-based explanation we start by modelling the impact of trust on portfolio decisions. Not only does the model provide testable implications, but it also gives us a sense of the economic importance of this phenomenon. In the absence of any cost of participation, a low level of trust can explain why a large fraction of individuals do not invest in the stock market. In addition, the model shows that lack of trust amplifies the effect of costly participation. For example, if an investor thinks that there is a 3% probability that he will be cheated, the threshold level of. | _ _ __ _ _ _ _ _ _ IS STOCK PICKING DECLINING AROUND THE WORLD Utpal Bhattacharya Kelley School of Business Indiana University ubhattac@ Neal Galpin Kelley School of Business Indiana University ngalpin@ November 15 2005 Key words modern portfolio theory indexing stock picking JEL number G11 G14 G15 We are grateful for suggestions from Craig Holden Chris Lundblad and seminar participants at Indiana University. IS STOCK PICKING DECLINING AROUND THE WORLD Abstract We do three things in this paper. We first develop a metric to measure the maximum fraction of volume explained by stock picking in a market. We then use our metric to measure stock picking around the world. We find that though there is more stock picking in emerging markets than in developed countries it is declining everywhere. In the United States for example stock picking has secularly declined from a high of 60 in the 1960s to a low of 24 in the 2000s. Finally as markets cannot be efficient if everyone believes that they are efficient and therefore do no stock picking - the Grossman and Stiglitz 1980 paradox - we ask what is the long-run steady state fraction of stock pickers We develop a simple theoretical model and calibrate this model to the United States economy to conclude that stock picking will eventually settle at 11 of trading volume in the United States. IS STOCK PICKING DECLINING AROUND THE WORLD I. INTRODUCTION A small gamble in a large number of different companies where I have no information to reach a good judgment as compared with a substantial stake in a company where one s information is adequate strikes me as a travesty of investment policy John Maynard Keynes 1883-1946 John Maynard Keynes was a good stock picker. From 1928 to 1945 the fund he managed for King s College Cambridge produced positive returns at a time when the . stock market was declining by per The intellectual foundations of stock picking were laid out in the classic text on .

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