Factor Demand and Factor Returns

58 Pages Posted: 13 Feb 2019 Last revised: 4 Apr 2022

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: October 3, 2021

Abstract

We propose a novel source of predictable price pressure resulting from mutual funds’ factor rebalancing behavior. When a fund’s factor demand is persistent, it needs to rebalance the portfolio’s factor exposure, leading to predictable trading at the stock level. This form of predictable trading operates independently from trading induced by retail flows and has distinct implications for cross-sectional return predictability. Consistent with demand-induced price pressure, stocks whose characteristics are well-matched with the underlying funds’ factor demand experience more buying pressure and higher returns, whereas mismatched stocks experience more selling and lower returns. We calculate the scale of factor rebalancing and estimate an average factor demand elasticity of -0.23.

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 (October 3, 2021). 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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