Institutional Investors: Arbitrageurs or Rational Trend Chasers

70 Pages Posted: 26 Feb 2016 Last revised: 30 Mar 2018

See all articles by Yeqin Zeng

Yeqin Zeng

Durham University Business School, Finance and Economics

Date Written: February 25, 2016

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 positive 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.

Keywords: nstitutional Investors; Stock Misvaluation; Factor Models

JEL Classification: G20; G12; G14

Suggested Citation

Zeng, Yeqin, Institutional Investors: Arbitrageurs or Rational Trend Chasers (February 25, 2016). International Review of Financial Analysis, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2737957 or http://dx.doi.org/10.2139/ssrn.2737957

Yeqin Zeng (Contact Author)

Durham University Business School, Finance and Economics ( email )

Office 162 Durham University Business School
Mill Hill Lane
Durham, DH1 3LB
United Kingdom

HOME PAGE: http://https://sites.google.com/site/yeqinzenghomepage/

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