Institutional Investors and the Informational Efficiency of Prices

Abstract

The percentage of U.S. equity held by institutional investors has quadrupled in the past four decades, and a prominent share of trading activity is due to institutions. Yet we know little about how institutions affect the informational efficiency of share prices, one important dimension of market quality. We study a broad cross-section of NYSE-listed stocks between 1983 and 2003, using measures of the relative informational efficiency of prices constructed from transaction data. We find that stocks with greater institutional ownership are priced more efficiently in the sense that their transaction prices more closely follow a random walk. Moreover, efficiency improves following exogenous shocks in institutional ownership. Finally, we demonstrate that increases in actual institutional trading volume are associated with greater efficiency, an effect that appears to be distinct from the effect associated with cross-sectional differences in institutional holdings.

Keywords: Market efficiency, institutional investors, asset pricing

JEL Classification: G14, G23, G12