Trading Opportunities and the Portfolio Choice of Institutional Investors

Abstract

This paper studies the portfolio choice of institutional investors with short holding horizons. Theoretically, only short-horizon institutions can routinely profit from the temporary mispricing of a stock. Stocks that are more susceptible to temporary mispricing attract more demand from short-horizon institutions, which in turn increases the average price of these stocks and drives out demand from other investors. Empirically, I find that stocks held more by short-horizon institutions have lower expected returns and provide more short-term trading opportunities, as my model predicts. My results demonstrate how institutional investors with different holding horizons allocate their capital and affect stock returns.

Keywords: institutional investor, investment horizon, mispricing, performance

JEL Classification: G11, G12, G14