How Does the Speed of Capital Flows Affect Factor Momentum, Reversal and Volatility?
85 Pages Posted: 1 Oct 2020 Last revised: 19 Apr 2021
Date Written: April 16, 2021
We document that hedge-fund and mutual-fund flows drive much of anomaly-return dynamics by, respectively, correcting and amplifying anomalies, and doing so slowly. Indeed, their contributions to the autocorrelation and volatility of anomaly returns add up to 57% over horizons longer than one year, vs. a few percent over shorter horizons. Thus, flows cause long-horizon factor momentum and stock excess volatility, not transient fluctuations. This effect is more pronounced for hedge funds, helmed by fund managers rather than fund investors, and linked to frictions. We address endogeneity concerns and propose a model highlighting the horizon-dependent effects of capital on anomaly-return dynamics.
Keywords: pricing anomalies; market efficiency; return autocorrelation; factor momentum; excess volatility; mutual funds; hedge funds; slow-moving capital; frictions; limits to arbitrage; spectral analysis.
JEL Classification: G12, G14, G23
Suggested Citation: Suggested Citation