The Sound of Many Funds Rebalancing

36 Pages Posted: 16 Apr 2016 Last revised: 11 Nov 2017

See all articles by Alexander Chinco

Alexander Chinco

University of Illinois at Urbana-Champaign - College of Business

Vyacheslav Fos

Boston College - Department of Finance; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: November 10, 2017

Abstract

This paper proposes that long rebalancing cascades (stock A’s price jumps, which causes a fund to buy stock A and sell stock B, which causes a second fund to sell stock B and buy stock C, which causes...) generate noise in financial markets. First, we use a random-networks model to show that, when funds follow many different threshold-based trading strategies, a change in stock A’s fundamentals can trigger a long rebalancing cascade that eventually affects the demand for unrelated stocks, like stock Z. Then, we prove that in a large market it’s computationally infeasible to predict whether a long rebalancing cascade will result in buy or sell orders for stock Z. The best you can do is compute stock Z’s susceptibility to these erratic non-fundamental demand shocks. By analogy, although the population of France is not a random number, whether this number is even or odd may as well be (Keynes, 1921). Finally, we use data on exchange-traded funds (ETFs) to give empirical evidence for our noise-generating mechanism. We find that, in the days immediately after a stock is announced as an M&A target, unrelated stocks on the other side of the market realize larger increases in trading volume when they are more susceptible to long rebalancing cascades. And, this additional trading volume is associated with higher levels of liquidity and more informed trading, suggesting that market participants view these long rebalancing cascades as noise.

Keywords: Noise, Exchange-Traded Funds, Index-Linked Investing, Trading Volume

JEL Classification: G02, G12, G14

Suggested Citation

Chinco, Alexander and Fos, Vyacheslav, The Sound of Many Funds Rebalancing (November 10, 2017). Available at SSRN: https://ssrn.com/abstract=2764941 or http://dx.doi.org/10.2139/ssrn.2764941

Alexander Chinco

University of Illinois at Urbana-Champaign - College of Business ( email )

Champaign, IL 61820
United States

Vyacheslav Fos (Contact Author)

Boston College - Department of Finance ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

European Corporate Governance Institute (ECGI) ( email )

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

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Register to save articles to
your library

Register

Paper statistics

Downloads
296
rank
99,888
Abstract Views
1,375
PlumX Metrics