Investors’ Horizons and the Amplification of Market Shocks

60 Pages Posted: 18 Sep 2010 Last revised: 4 Jun 2012

Cristina Cella

Stockholm School of Economics; Swedish House of Finance; Centre for Studies in Economics and Finance (CSEF); Sverige Riksbank

Andrew Ellul

Indiana University - Kelley School of Business - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); University of Naples Federico II - CSEF - Center for Studies in Economics and Finance

Mariassunta Giannetti

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Swedish House of Finance

Date Written: May 2011

Abstract

During episodes of market turmoil, institutional investors with short trading horizons are inclined or forced to sell their holdings to a larger extent than investors with longer trading horizons. This may amplify the effects of market-wide shocks on the prices of stocks held by short horizon investors. We test the relevance of this mechanism by exploiting the negative shock caused by Lehman Brothers’ bankruptcy in September 2008. Consistent with our conjecture, short-term investors sell significantly more than long-term investors around and after the Lehman Brothers’ bankruptcy. Most importantly, stocks held by short-term investors experience more severe price drops and larger price reversals than those held by long-term investors. Since they are obtained after controlling for contemporaneous net flows, the stocks’ exposure to innovations in implied volatility and aggregate liquidity, various firms’ and investors’ characteristics, including the momentum effect and the propensity of institutional investors to follow an index, our results cannot be explained by characteristics of the institutions’ investment strategy other than their investment horizons. We also show that the effect of investor trading horizon emerges during other episodes of severe market turmoil, such as the October 1987 market crash. Overall, the empirical evidence strongly indicates that investors’ short horizons amplify the effects of market-wide negative shocks.

Keywords: Fire sales, Institutional investors, Investor horizon, Market crashes, Financial crisis

JEL Classification: G11, G12, G14, G18, G22

Suggested Citation

Cella, Cristina and Ellul, Andrew and Giannetti, Mariassunta, Investors’ Horizons and the Amplification of Market Shocks (May 2011). ECGI - Finance Working Paper No. 298/2010. Available at SSRN: https://ssrn.com/abstract=1678021 or http://dx.doi.org/10.2139/ssrn.1678021

Cristina Cella

Stockholm School of Economics ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Centre for Studies in Economics and Finance (CSEF) ( email )

84084 Fisciano, Salerno
Italy

Sverige Riksbank ( email )

Brunkebergstorg 11
SE-103 37 Stockholm
Sweden

Andrew Ellul

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

University of Naples Federico II - CSEF - Center for Studies in Economics and Finance ( email )

Via Cintia
Complesso Monte S. Angelo
Naples, Naples 80126
Italy

Mariassunta Giannetti (Contact Author)

Stockholm School of Economics ( email )

P.O. Box 6501
Sveavagen 65
SE-113 83 Stockholm
Sweden
+46 8 736 9607 (Phone)
+46 8 312 327 (Fax)

HOME PAGE: http://sites.google.com/site/mariassuntagiannetti/Home

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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