Quantitative Investing and Price Informativeness

Abstract

We study, using a noisy rational expectations framework, how quantitative funds with superior access to price information but imperfect price interpretation affects price informativeness. Quantitative investing, on the one hand, brings more informed capital with superior price information, on the other hand, injects systematic noise into equilibrium outcomes due to common errors in the price processing. In a highly institutionalized market, the imperfect price interpretation of extra institutional money not only directly injects systematic noise but also indirectly confuses other institutions through their price interpretation, which further feedback to the trades of each institution through their demand and noise price interpretation. Hence, the price informativeness could decreases with institutionalization. In an equilibrium with an endogenously determined fund market structure, apart from inducing more capital flows to quantitative funds, lowering price information further motivates the formation of quantitative funds. This endogenous strategy-crowding makes noise information interpretation more correlated, distorting information aggregation and demoting price informativeness.

Keywords: Institutionalization, information efficiency, imperfect price interpretation

JEL Classification: D4, D53, D83, G02, G12, G14, G23, L10