This paper studies how institutional ownership structure affects stock return volatility through its interaction with market liquidity and trading behavior. I show that passive institutional investors amplify volatility in illiquid stocks by executing mechanical trades that are insensitive to market liquidity, while active institutions help stabilize prices. A theoretical model with endogenous informed trading and systematic passive flows explains these patterns. Empirical results using ownership data from 1980–2022 support the model’s predictions. The results suggest that volatility arises not from institutional ownership per se, but from the interaction between ownership structure and liquidity.