Follow the Leader: The Cause and Consequences of Fund Managers Trading in Signal-Strength Sequence

37 Pages Posted: 26 Mar 2008 Last revised: 21 Jul 2008

See all articles by Peter L. Swan

Peter L. Swan

University of New South Wales (UNSW Sydney; Financial Research Network (FIRN)

Kingsley Y. L. Fong

University of New South Wales - School of Banking and Finance

Peter Gardner

Plato Investment Management

David R. Gallagher

Rozetta Institute

Date Written: July 18, 2008

Abstract

In a sequence of trades in the same direction across fund managers, we expect the long-term return of a trade to be increasing in the number of subsequent trades if fund managers' trading is driven by private information. In contrast, information cascades imply the lack of such a relationship. Using the number of brokers and the number of zero trading days prior to a trade to identify the beginning of a trade sequence in our daily fund manager trade series, we find evidence of private information trading when there are less than four fund managers in a trade sequence and information cascade when there are four or more fund managers. We discover that multiple-broker trades have higher price impact as well as higher long-term returns. These trades are also associated with fewer subsequent trades by other fund managers. Finally, we observe that the post-completion returns of the lead trades in a trade sequence are increasing in the managers' portfolio weights in excess of the index weights. While there is evidence that fund managers follow the trades of their peers, they typically trade on private information and they leave some 'money on the table' when they face binding risk constraints.

Keywords: Herding, Informational cascades, Trade sequences, Leader and follower trades

JEL Classification: G14, G23

Suggested Citation

Swan, Peter Lawrence and Fong, Kingsley Y. L. and Gardner, Peter and Gallagher, David R., Follow the Leader: The Cause and Consequences of Fund Managers Trading in Signal-Strength Sequence (July 18, 2008). Available at SSRN: https://ssrn.com/abstract=508822 or http://dx.doi.org/10.2139/ssrn.508822

Peter Lawrence Swan (Contact Author)

University of New South Wales (UNSW Sydney ( email )

School of Banking and Finance
UNSW Business School
Sydney NSW, NSW 2052
Australia
+61 2 9385 5871 (Phone)
+61 2 9385 6347 (Fax)

HOME PAGE: http://https://www.business.unsw.edu.au/our-people/peterswan

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Kingsley Y. L. Fong

University of New South Wales - School of Banking and Finance ( email )

UNSW Business School
High St
Sydney, NSW 2052
Australia

Peter Gardner

Plato Investment Management ( email )

Level 14, 167 Macquarie St
Sydney, New South Wales 2066
Australia

David R. Gallagher

Rozetta Institute ( email )

Sydney

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