Factor Demand and Factor Returns

55 Pages Posted: 13 Feb 2019 Last revised: 13 Jan 2021

See all articles by Cameron Peng

Cameron Peng

London School of Economics & Political Science (LSE) - Department of Finance

Chen Wang

University of Notre Dame - Mendoza College of Business

Date Written: February 1, 2019

Abstract

A mutual fund’s demand for a pricing factor, measured by the loading of the fund’s returns on the factor’s returns, is persistent over time. When stock characteristics are time-varying and change frequently, persistence in factor demand generates a need for rebalancing. This rebalancing motive, in turn, leads to predictable trading from mutual funds and contributes to cross-sectional return predictability. In particular, when there is a “mismatch” between a stock’s characteristic and the underlying funds’ demand for that characteristic, the “mismatched” stock will face selling pressure from the underlying funds and subsequently earn lower returns. Double-sorting on stocks’ characteristics and mutual funds’ factor demand refines value and momentum strategies, generating abnormal returns that cannot be explained by subsequent fundamentals or retail trading flows.

Keywords: Factor Rebalancing, Mutual Funds, Price Pressure, Factor Returns

JEL Classification: G12, G23, G40

Suggested Citation

Peng, Cameron and Wang, Chen, Factor Demand and Factor Returns (February 1, 2019). Available at SSRN: https://ssrn.com/abstract=3327849 or http://dx.doi.org/10.2139/ssrn.3327849

Cameron Peng (Contact Author)

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

Chen Wang

University of Notre Dame - Mendoza College of Business ( email )

Notre Dame, IN 46556-5646
United States

HOME PAGE: http://chenwang.one/

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