Institutional Investors and the Informational Efficiency of Prices
51 Pages Posted: 31 Aug 2005
Date Written: July 24, 2007
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 2004 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. This result cannot be attributed to liquidity effects and is not likely the result of reverse causality. We also show that institutional trading activity is one mechanism by which prices become more efficient, even when institutions trade passively or follow momentum strategies.
Keywords: market efficiency, institutional investors, institutional trading, market quality
JEL Classification: G14, G12
Suggested Citation: Suggested Citation