Positive Feedback Trading and Stock Prices: Evidence from Mutual Funds
48 Pages Posted: 13 Feb 2019
Date Written: February 1, 2019
We show that mutual funds contribute to cross-sectional momentum and excess volatility through positive feedback trading. Stocks held by positive feedback funds exhibit much stronger momentum, almost doubling the returns from a simple momentum strategy. This “enhanced” momentum is robust to alternative measures of positive feedback trading and cannot be explained by other stock characteristics, ex-post firm fundamentals, fund flows, or herding. Moreover, enhanced momentum is almost fully reversed after one quarter, suggesting initial overshooting and subsequent reversal. We argue the most likely explanation is the price pressure from positive feedback trading. Finally, we relate positive feedback trading to mutual fund performance and show that it can positively predict a fund’s return from active management.
Keywords: Positive Feedback Trading, Mutual Funds, Price Pressure, Momentum
JEL Classification: G12, G23, G40
Suggested Citation: Suggested Citation