Naïve Style-level Feedback Trading in Passive Funds
66 Pages Posted: 3 Jun 2017 Last revised: 29 May 2020
Date Written: December 1, 2016
Passive ETFs are ideally suited for 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 the less sophisticated ones, are style momentum traders themselves. Recent style-level demand predicts style-level return reversals. These findings suggest that naïve positive feedback trading, especially by institutions, can destabilize financial markets in the short run.
Keywords: Positive feedback trading, institutional trading, non-fundamental demand, exchange-traded fund, return predictability.
JEL Classification: G10, G11, G14, G23
Suggested Citation: Suggested Citation