Portfolio Spillovers and a Limit to Diversification
50 Pages Posted: 8 Jan 2014 Last revised: 9 Sep 2016
Date Written: January 19, 2015
Securities are exposed to the return shocks of seemingly unrelated securities in common mutual fund portfolios. Shocks to firm returns mechanically affect fund returns that hold these securities, which induce investor-driven flows and rebalancing, resulting in temporary flow-induced price pressure (FIPP) on other firms in common portfolios. Instrumenting to address flow/return endogeneity, a one standard deviation increase in the FIPP corresponds to a 15-60 bps increase in daily abnormal firm returns. This pressure reverses in 5-6 days and is larger for liquid firms and for funds experiencing outflows. Failing to properly estimate this correlation implies that an investor is exposed to nonsystematic risk.
Keywords: Spillover, Idiosyncratic Returns, Mutual Funds
JEL Classification: G12, G20, G14, G11
Suggested Citation: Suggested Citation