Do Index Funds Stabilize Stock Prices?Evidence Based on Regression Discontinuity Design
SHEN Yu, WANG Boxuan, YANG Qingqing, MAO Xilin
School of Finance, Southwestern University of Finance and Economics;Hefei Xingtai Financial Holdings (Group) Co., Ltd.;Research and Development Center, Western Securities Co., Ltd.
Summary:
Passive investing has expanded rapidly across global markets, and China has undergone a similar transition. By 2023, the size of domestic index funds had grown nearly eightfold since 2010, with the number of funds rising from fewer than one hundred to more than one thousand. In the third quarter of 2024, equity holdings of index funds exceeded those of active funds for the first time. In this context, understanding whether index funds amplify or stabilize stock-price fluctuations in China has become a central question for both regulators and market participants. Theoretically, index funds may influence price stability through competing channels. On the one hand, inclusion in major indices increases visibility and reduces the sensitivity of prices to short-term noise. On the other hand, as index-fund scale expands, large passive flows may reduce free-floating shares and create mechanical trading pressure during subscription and redemption cycles, potentially amplifying short-term volatility. Determining which effect dominates requires credible empirical identification. This study exploits the institutional features of the CSI 300 and CSI 500 indices to construct a quasi-natural experiment. Index constituents are ranked by average total market capitalization, with semiannual adjustments that shift firms across a well-defined threshold. Near this cutoff, firms in the lower end of the CSI 300 and firms in the upper end of the CSI 500 share similar fundamentals, yet their index weights and index-fund ownership differ sharply due to index-tracking rules. This discontinuity provides a clean source of variation that allows us to identify the causal impact of index-fund ownership on price stability. Using data from 2013 to 2020, we implement a fuzzy regression discontinuity design (RDD). The first-stage results reveal a sizable jump in index-fund ownership at the cutoff, with CSI 300 tail firms receiving substantially higher passive holdings. This “tail-head” pattern reflects China's market characteristics, including the dominance of large-cap index products and the smaller overall market scale. The second-stage estimates show that higher index-fund ownership significantly enhances price stability, reducing volatility, idiosyncratic volatility, return amplitude, downside tail risk, and limit-down events, while leaving limit-up events unchanged. These patterns indicate an asymmetric stabilizing effect that mainly suppresses extreme negative movements. To uncover the mechanisms behind these patterns, we examine firms' information disclosure, managerial tone, earnings quality, and equity-pledging behavior. Firms with higher index-fund ownership exhibit more cautious narrative tone in annual reports, higher reporting quality, and lower reliance on equity pledging, suggesting that index funds improve internal governance and discipline managerial behavior. These improvements reduce firms' sensitivity to short-term sentiment shocks and strengthen the anchoring role of fundamentals in price formation. Additional analyses rule out alternative channels such as liquidity effects and active-fund rebalancing. Further results show that the stabilizing effect persists across different market conditions. Index funds reduce price swings in both bull and bear markets, although the channels differ. In bull markets, the effect is more apparent in limiting excessive short-term movements, whereas in bear markets, it is more closely associated with mitigating crash risk and preventing panic-driven sell-offs. This study makes several contributions. First, it provides the first systematic evidence on the unique “tail-head” ownership structure in China, revealing how the configuration of passive capital differs from that in developed markets. Second, moving beyond exchange-traded funds, it evaluates the comprehensive influence of index funds, on price stability, showing that passive ownership has long-term governance implications. Third, it identifies the governance channel as the primary mechanism through which index funds stabilize prices, supported by evidence on disclosure behavior, managerial tone, and earnings quality. Fourth, it offers new insights for policy design, particularly regarding the development of patient capital, the optimization of index-fund product structures, and the long-term stability of China's capital market. The findings yield several policy recommendations. Strengthening long-horizon assessment frameworks, improving product-design and index-construction rules, and enhancing standards for disclosure, internal control, and risk management will help reinforce index funds' stabilizing function. At a broader level, increasing the share of long-term funds and improving investor structure can enhance market resilience and reduce the influence of short-term speculative trading. These implications align with current efforts to support the high-quality development of the public-fund industry and to promote the long-term healthy functioning of China's capital market.
申宇, 王博煊, 杨青青, 毛希林. 指数基金是否稳定了股价？——来自断点回归的证据[J]. 金融研究, 2026, 548(2): 188-206.
SHEN Yu, WANG Boxuan, YANG Qingqing, MAO Xilin. Do Index Funds Stabilize Stock Prices?Evidence Based on Regression Discontinuity Design. Journal of Financial Research, 2026, 548(2): 188-206.
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