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The Trading Dynamics Of Institutional Investors

1474 words - 6 pages

The fraction of corporate equity owned by institutional investors has grown considerably in the past several decades; institutional holding of shares in U.S. equities has increased from approximately 16% in 1965 to over 50% in 2010 (Federal Reserve Board, 2011). The fact that institutional investors are managing such a sizable wealth invested in U.S. equity market has potential important role in term of setting market prices. The growing impact of institutional investors on capital markets has induced to increased research on the behavior of this group of investors both by academics and policy makers, who tend to believe that institutional investor follow momentum based strategies, and often are alleged to herdinglike behavior and following destabilizing trading strategies.

Recent studies investigating the behavior of institutional investors document three main results. First, institutional investors are momentum traders (buying past winners and selling past losers) and are more likely to follow past prices (\citet*{grinblatt1995momentum}). Second, Institutional investors sometimes trade in the same direction over a period of time or engage in herding behavior (\citet{wermers1999mutual}). Finally, the contemporaneous association between changes in quarterly institutional holding and quarterly stock returns is much stronger than the feedback trading effect (\citet{nofsinger1999herding,wermers1999mutual}).

The previous studies on the behavior of institutional investors suffer from lack of publicly available institutional trading data and basically rely on quarterly institutional holding data to compute changes in institutional ownership. In contrast, using daily institutional investors' transaction data from ANcerno Ltd, a private transaction costs analyst, we are able to examine the existing empirical evidence on the relationship between returns and trading activity of institutional investors found at quarterly intervals, and separately investigate the relative importance of the trading activity of institutional investors in: (1) following past price movements, (2) predicting future stock returns, and (3) the contemporaneous relation with stock returns.

Our study contributes to the current literature on the behavior of institutional investors by using actual institutional transactional data to examine the relation between institutional trading activity and returns. This study overcomes the limitations of quarterly institutional ownership by employing a proprietary database of institutional trades distributed by ANcerno Ltd., a private transaction costs analyst. The ANcerno data are uniquely suited to examine the relation between institutional trading activity and returns, since they contain detailed information on trades that approximately account for 8 % of the total volume in CRSP in each of the years that we study.\footnote{These data have been released to academic researcher and produced various studies including...

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