The impact of institutional trading on stock prices
TL;DR: In this paper, the authors used new data on the holdings of 769 tax-exempt (predominantly pension) funds, to evaluate the potential effect of their trading on stock prices.
About: This article is published in Journal of Financial Economics.The article was published on 1992-08-01 and is currently open access. It has received 1700 citations till now. The article focuses on the topics: Alternative trading system & Open outcry.
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TL;DR: In this article, the authors provide evidence that value strategies yield higher returns because these strategies exploit the suboptimal behavior of the typical investor and not because these riskier strategies are fundamentally riskier.
Abstract: For many years, scholars and investment professionals have argued that value strategies outperform the market. These value strategies call for buying stocks that have low prices relative to earnings, dividends, book assets, or other measures of fundamental value. While there is some agreement that value strategies produce higher returns, the interpretation of why they do so is more controversial. This article provides evidence that value strategies yield higher returns because these strategies exploit the suboptimal behavior of the typical investor and not because these strategies are fundamentally riskier. FOR MANY YEARS, SCHOLARS and investment professionals have argued that
3,491 citations
TL;DR: In this paper, the authors present a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models.
Abstract: The basic paradigm of asset pricing is in vibrant f lux. The purely rational approach is being subsumed by a broader approach based upon the psychology of investors. In this approach, security expected returns are determined by both risk and misvaluation. This survey sketches a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models.
1,796 citations
TL;DR: In this paper, the authors examine a potential agency conflict between mutual fund investors and mutual fund companies, where investors would like the fund company to use its judgment to maximize risk-adjusted fund retraction.
Abstract: This paper examines a potential agency conflict between mutual fund investors and mutual fund companies. Investors would like the fund company to use its judgment to maximize risk‐adjusted fund ret...
1,752 citations
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TL;DR: This paper examined the investment strategies of 155 mutual funds over the 1975-84 period to determine the extent to which the funds purchased stocks based on their past returns, and determine the relation of this behavior to their observed portfolio performance.
Abstract: We examine the investment strategies of 155 mutual funds over the 1975-84 period to determine the extent to which the funds purchased stocks based on their past returns, and to determine the relation of this behavior to their observed portfolio performance We find that about 77% of these mutual funds were "momentum investors", buying stocks that were past winners; however, they did not systematically sell past losers On average, these "trend-followers" realized significantly better performance than the remaining funds We also find that the mutual funds exhibited herding behavior, and that the tendency of a fund to herd in its trades was strongly correlated with its tendency to buy past winners as well as with its portfolio performance Consistent with the evidence on trend-following, herding into past winners was stronger than herding into past losers
1,685 citations
TL;DR: In this article, a strong positive correlation between changes in institutional ownership and returns measured over the same period was found, which suggests that either institutional investors positive-feedback trade more than individual investors or institutional herding impacts prices more than herding by individual investors.
Abstract: We document strong positive correlation between changes in institutional ownership and returns measured over the same period. The result suggests that either institutional investors positive-feedback trade more than individual investors or institutional herding impacts prices more than herding by individual investors. We find evidence that both factors play a role in explaining the relation. We find no evidence, however, of return mean-reversion in the year following large changes in institutional ownership—stocks institutional investors purchase subsequently outperform those they sell. Moreover, institutional herding is positively correlated with lag returns and appears to be related to stock return momentum. HERDING AND FEEDBACK TRADING HAVE THE POTENTIAL to explain a number of financial phenomena, such as excess volatility, momentum, and reversals in stock prices. Herding is a group of investors trading in the same direction over a period of time; feedback trading involves correlation between herding and lag returns. 1 Although a recent growing body of literature is devoted to investor herding and feedback trading, extant studies take divergent paths. One path depicts individual investors as engaging in herding as a result of irrational, but systematic, responses to fads or sentiment. A second path depicts institutional investors engaging in herding as a result of agency problems, security characteristics, fads, or the manner in which information is impounded in the market.
1,542 citations
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TL;DR: In this article, a study of market efficiency investigates whether people tend to "overreact" to unexpected and dramatic news events and whether such behavior affects stock prices, based on CRSP monthly return data, is consistent with the overreaction hypothesis.
Abstract: Research in experimental psychology suggests that, in violation of Bayes' rule, most people tend to "overreact" to unexpected and dramatic news events. This study of market efficiency investigates whether such behavior affects stock prices. The empirical evidence, based on CRSP monthly return data, is consistent with the overreaction hypothesis. Substantial weak form market inefficiencies are discovered. The results also shed new light on the January returns earned by prior "winners" and "losers." Portfolios of losers experience exceptionally large January returns as late as five years after portfolio formation. As ECONOMISTS INTERESTED IN both market behavior and the psychology of individual decision making, we have been struck by the similarity of two sets of empirical findings. Both classes of behavior can be characterized as displaying overreaction. This study was undertaken to investigate the possibility that these phenomena are related by more than just appearance. We begin by describing briefly the individual and market behavior that piqued our interest. The term overreaction carries with it an implicit comparison to some degree of reaction that is considered to be appropriate. What is an appropriate reaction? One class,,of tasks which have a well-established norm are probability revision problems for which Bayes' rule prescribes the correct reaction to new information. It has now been well-established that Bayes' rule is not an apt characterization of how individuals actually respond to new data (Kahneman et al. [14]). In revising their beliefs, individuals tend to overweight recent information and underweight prior (or base rate) data. People seem to make predictions according to a simple matching rule: "The predicted value is selected so that the standing of the case in the distribution of outcomes matches its standing in the distribution of impressions" (Kahneman and Tversky [14, p. 416]). This rule-of-thumb, an instance of what Kahneman and Tversky call the representativeness heuristic, violates the basic statistical principal that the extremeness of predictions must be moderated by considerations of predictability. Grether [12] has replicated this finding under incentive compatible conditions. There is also considerable evidence that the actual expectations of professional security analysts and economic forecasters display the same overreaction bias (for a review, see De Bondt [7]). One of the earliest observations about overreaction in markets was made by J. M. Keynes:"... day-to-day fluctuations in the profits of existing investments,
7,032 citations
TL;DR: In this article, the authors analyze a sequential decision model in which each decision maker looks at the decisions made by previous decision makers in taking her own decision, and they show that the decision rules that are chosen by optimizing individuals will be characterized by herd behavior.
Abstract: We analyze a sequential decision model in which each decision maker looks at the decisions made by previous decision makers in taking her own decision. This is rational for her because these other decision makers may have some information that is important for her. We then show that the decision rules that are chosen by optimizing individuals will be characterized by herd behavior; i.e., people will be doing what others are doing rather than using their information. We then show that the resulting equilibrium is inefficient.
5,956 citations
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TL;DR: It is argued that localized conformity of behavior and the fragility of mass behaviors can be explained by informational cascades.
Abstract: An informational cascade occurs when it is optimal for an individual, having observed the actions of those ahead of him, to follow the behavior of the preceding individual without regard to his own information. We argue that localized conformity of behavior and the fragility of mass behaviors can be explained by informational cascades.
5,412 citations
TL;DR: In this paper, the authors argue that localized conformity of behavior and the fragility of mass behaviors can be explained by informational cascades, where an individual, having observed the actions of those ahead of him, to follow the behavior of the preceding individual without regard to his own information.
Abstract: An informational cascade occurs when it is optimal for an individual, having observed the actions of those ahead of him, to follow the behavior of the preceding individual without regard to his own information. We argue that localized conformity of behavior and the fragility of mass behaviors can be explained by informational cascades.
4,731 citations
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TL;DR: In this paper, the authors examine some of the forces that can lead to herd behavior in investment and discuss applications of the model to corporate investment, the stock market, and decision making within firms.
Abstract: This paper examines some of the forces that can lead to herd behavior in investment. Under certain circumstances, managers simply mimic the investment decisions of other managers, ignoring substantive private information. Although this behavior is inefficient from a social standpoint, it can be rational from the perspective of managers who are concerned about their reputations in the labor market. We discuss applications of the model to corporate investment, the stock market, and decision making within firms. (JEL 026, 522) A basic tenet of classical economic theory is that investment decisions reflect agents' rationally formed expectations; decisions are made using all available information in an efficient manner. A contrasting view is that investment is also driven by group psychology, which weakens the link between information and market outcomes. In The General Theory, John Maynard Keynes (1936, pp. 157-58) expresses skepticism about the ability and inclination of "long-term investors" to buck market trends and ensure efficient investment. In his view, investors may be reluctant to act according to their own information and beliefs, fearing that their contrarian behavior will damage their reputations as sensible decision makers:
2,676 citations