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Institutional investors: Arbitrageurs or rational trend chasers

Zeng, Yeqin

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Abstract

This paper studies the relationship between institutional investor holdings and stock misvaluation in the U.S. between 1980 and 2010. I find that institutional investors overweigh overvalued and underweigh undervalued stocks in their portfolio, taking the market portfolio as a benchmark. Cross-sectionally, institutional investors hold more overvalued stocks than undervalued stocks. The time-series studies also show that institutional ownership of overvalued portfolios increases as the portfolios' degree of overvaluation. As an investment strategy, institutional investors' ride of stock misvaluation is neither driven by the fund flows from individual investors into institutions, nor industry-specific. Consistent with the agency problem explanation, investment companies and independent investment advisors have a higher tendency to ride stock misvaluation than other institutions. There is weak evidence that institutional investors make a profit by riding stock misvaluation. My findings challenge the models that view individual investors as noise traders and disregard the role of institutional investors in stock market misvaluation.

Citation

Zeng, Y. (2016). Institutional investors: Arbitrageurs or rational trend chasers. International Review of Financial Analysis, 45, 240-262. https://doi.org/10.1016/j.irfa.2016.03.006

Journal Article Type Article
Acceptance Date Mar 7, 2016
Online Publication Date Mar 26, 2016
Publication Date May 1, 2016
Deposit Date Sep 21, 2018
Publicly Available Date Mar 29, 2024
Journal International Review of Financial Analysis
Print ISSN 1057-5219
Publisher Elsevier
Peer Reviewed Peer Reviewed
Volume 45
Pages 240-262
DOI https://doi.org/10.1016/j.irfa.2016.03.006
Public URL https://durham-repository.worktribe.com/output/1319173

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