Institutional investors: Arbitrageurs or rational trend chasers

Zeng, Yeqin

Abstract

This paper studies the relationship between institutional investor holdings and stock misvaluation in the U.S. between 1980 and 2010. I find that institutional investors overweigh overvalued and underweigh undervalued stocks in their portfolio, taking the market portfolio as a benchmark. Cross-sectionally, institutional investors hold more overvalued stocks than undervalued stocks. The time-series studies also show that institutional ownership of overvalued portfolios increases as the portfolios' degree of overvaluation. As an investment strategy, institutional investors' ride of stock misvaluation is neither driven by the fund flows from individual investors into institutions, nor industry-specific. Consistent with the agency problem explanation, investment companies and independent investment advisors have a higher tendency to ride stock misvaluation than other institutions. There is weak evidence that institutional investors make a profit by riding stock misvaluation. My findings challenge the models that view individual investors as noise traders and disregard the role of institutional investors in stock market misvaluation.

Citation

Zeng, Y. (2016). Institutional investors: Arbitrageurs or rational trend chasers. International Review of Financial Analysis, 45, 240-262. https://doi.org/10.1016/j.irfa.2016.03.006

• Journal Article Type: Article
• Acceptance Date: Mar 7, 2016
• Online Publication Date: Mar 26, 2016
• Publication Date: May 1, 2016
• Deposit Date: Sep 21, 2018
• Publicly Available Date: Sep 26, 2018
• Journal: International Review of Financial Analysis
• Print ISSN: 1057-5219
• Electronic ISSN: 1873-8079
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 45
• Pages: 240-262
• DOI: https://doi.org/10.1016/j.irfa.2016.03.006
• Public URL: https://durham-repository.worktribe.com/output/1319173