Naïve Style-level Feedback Trading in Passive Funds
Journal of Financial and Quantitative Analysis, forthcoming
64 Pages Posted: 3 Jun 2017 Last revised: 16 Oct 2020
Date Written: October 13, 2020
Passive Exchange-Traded Funds (ETFs) are ideally suited to style-level feedback trading because of their high liquidity, ease of short-selling, and pure play on investment styles. I find strong evidence of short-term style momentum trading in ETFs. Institutional investors that use ETFs do not act as arbitrageurs by trading against style momentum. Institutions, especially less sophisticated ones, are themselves style momentum traders. Moreover, recent style-level demand predicts style-level return reversals. These findings suggest that uninformed positive feedback trading by less sophisticated market participants can destabilize financial markets in the short run.
Keywords: Positive Feedback Trading, Style-Switching, Institutional Investors, Non-Fundamental Demand, Exchange-Traded Fund (ETF), Return Predictability.
JEL Classification: G10, G11, G14, G23
Suggested Citation: Suggested Citation