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
Date Written: July 18, 2008
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: Suggested Citation