When Does a Mutual Fund's Trade Reveal its Skill?

52 Pages Posted: 29 Nov 2007 Last revised: 25 Sep 2010

See all articles by Pengjie Gao

Pengjie Gao

University of Notre Dame - Mendoza College of Business

Zhi Da

University of Notre Dame - Mendoza College of Business

Ravi Jagannathan

Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER); Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF); Indian School of Business (ISB), Hyderabad

Date Written: November 2007

Abstract

We conjecture that a mutual fund manager with superior stock selection ability is more likely to benefit from trading in stocks affected by information-events. Taking the probability of informed trading (PIN, Easley, Kiefer, O'Hara, and Paperman, 1996) to measure the amount of informed trading in a stock, and inferring mutual fund trades from a large sample of mutual fund holdings, we provide empirical support for the conjecture. Funds trading high-PIN stocks exhibit superior performance on average, and superior performance that is more likely to persist. The findings are not due to price momentum or the higher returns earned by high-PIN stocks on average. Conclusions remain the same after testing for alternative measures for the amount of informed trading. Decomposing a fund's stock selection ability into "informed trading" and "liquidity provision" adds further insight into fund's underlying strengths. Impatient informed trading is a significant source of alpha for funds trading high-PIN stocks, while liquidity provision is more important as a source of alpha for funds trading low-PIN stocks.

Suggested Citation

Gao, Pengjie and Da, Zhi and Jagannathan, Ravi, When Does a Mutual Fund's Trade Reveal its Skill? (November 2007). NBER Working Paper No. w13625. Available at SSRN: https://ssrn.com/abstract=1033751

Pengjie Gao

University of Notre Dame - Mendoza College of Business ( email )

246 Mendoza College of Business
Notre Dame, IN 46556-5646
United States
(574) 631-8048 (Phone)

Zhi Da

University of Notre Dame - Mendoza College of Business ( email )

Notre Dame, IN 46556-5646
United States

Ravi Jagannathan (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
429 Andersen Hall
Evanston, IL 60208
United States
847-491-8338 (Phone)
847-491-5719 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Indian School of Business (ISB), Hyderabad ( email )

Hyderabad, Gachibowli 500 019
India

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