Factor Demand and Factor Returns
58 Pages Posted: 13 Feb 2019 Last revised: 4 Apr 2022
Date Written: October 3, 2021
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: Suggested Citation