Institutional Investors, Financial Market Efficiency and Financial Stability

Emphasising the scope for further growth in institutional investment, in Europe in particular, this paper focuses on the impact of institutional investment on the efficiency and stability of financial systems. The paper stresses the scope for efficiency gains arising from an increasing role of institutional investors, reflecting – inter alia – their role in improving corporate governance. The paper also argues that institutional investors tend to enhance financial system stability although they may sporadically exacerbate market volatility or liquidity problems. This calls for a close focus of regulators and monetary policy makers on institutional behaviour, while inter alia continuing the shift envisaged in the current EU Pension Funds (IORP) Directive towards prudent person rules for investment, and focusing closely on the long term sustainability of guarantees being offered on life policies, annuities and pensions. * E. Philip Davis is Professor of Economics and Finance at Brunel University, West London and Visiting Fellow at the National Institute of Economic and Social Research, London ([email protected]; www.geocities.com/e_philip_davis). This paper draws in part on Davis and Steil (2001).