Hostname: page-component-5b777bbd6c-gtgcz Total loading time: 0 Render date: 2025-06-23T11:28:03.849Z Has data issue: false hasContentIssue false
  • English
  • Français

Institutional Investment Constraints and Stock Prices

Published online by Cambridge University Press:  09 March 2017

Jie Cao ,
Bing Han  and
Qinghai Wang
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

We test the hypothesis that investment constraints in delegated portfolio management may distort demand for stocks, leading to price underreaction to news and stock return predictability. We find that institutions tend not to buy more of a stock with good news that they already overweight; they are reluctant to sell a stock with bad news that they already underweight. Stocks with good news overweighted by institutions subsequently significantly outperform stocks with bad news underweighted by institutions. The impact of institutional investment constraints sheds new light on asset pricing anomalies such as stock price momentum and post–earnings announcement drift.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 52 , Issue 2 , April 2017 , pp. 465 - 489
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

Footnotes

1

We thank Stephen Brown (the editor), Aydogan Alti, Michael Brennan, John Griffin, Jean Helwege, David Hirshleifer, Kewei Hou, Jennifer Huang, Hao Jiang (the referee), Jonathan Lewellen, Stefan Nagel, Laura Starks, Rene Stulz, Michael Stutzer, Siew-Hong Teoh, Sheridan Titman, Ralph Walkling, Russ Wermers, Lu Zheng, and seminar participants at the Hong Kong University of Science and Technology, Peking University, Ohio State University, the University of Texas at Austin, the 2007 Financial Management Association Meetings, and the 2005 Western Finance Association Meetings for helpful discussions and comments. All remaining errors are our own. The work described in this paper was partially supported by a grant from the Research Grant Council of the Hong Kong Special Administrative Region, China (Project No. CUHK 458212).

References

Alankar, A.; Blaustein, P.; and Scholes, M.. “The Cost of Constraints: Risk Management, Agency Theory and Asset Prices.” Working Paper, Stanford University (2014).Google Scholar
Alexander, G.; Cici, G.; and Gibson, S.. “Does Trade Motivation Matter? An Analysis of Mutual Fund Trades.” Review of Financial Studies, 20 (2007), 125–150.CrossRefGoogle Scholar
Allen, F.“Do Financial Institutions Matter?” Journal of Finance, 56 (2001), 1165–1175.Google Scholar
Almazan, A.; Brown, K. C.; Carlson, M.; and Chapman, D. A.. “Why Constrain Your Mutual Fund Manager?” Journal of Financial Economics, 73 (2004), 289–321.Google Scholar
Arnott, R.“What Risk Matters? A Call for Papers!” Financial Analysts Journal, 59 (2003), 6–8.Google Scholar
Badrinath, S. G.; Gay, G. D.; and Kale, J. R.. “Patterns of Institutional Investment, Prudence, and the Managerial ‘Safety-Net’ Hypothesis.” Journal of Risk and Insurance, 56 (1989), 605–629.Google Scholar
Baker, M.; Litov, L.; Wachter, J.; and Wurgler, J.. “Can Mutual Fund Managers Pick Stocks? Evidence from the Trades Prior to Earnings Announcements.” Journal of Financial and Quantitative Analysis, 45 (2010), 1111–1131.Google Scholar
Barberis, N.; Shleifer, A.; and Vishny, R.. “A Model of Investor Sentiment.” Journal of Financial Economics, 49 (1998), 307–343.CrossRefGoogle Scholar
Bennett, J.; Sias, R.; and Starks, L.. “Greener Pastures and the Impact of Dynamic Institutional Preferences.” Review of Financial Studies, 16 (2003), 1203–1239.CrossRefGoogle Scholar
Bushee, B., and Noe, C.. “Corporate Disclosure Practices, Institutional Investors, and Stock Return Volatility.” Journal of Accounting Research, 38 (2000), 171–202.Google Scholar
Cai, F., and Zheng, L.. “Institutional Trading and Stock Returns.” Finance Research Letters, 1 (2004), 178–189.Google Scholar
Carpenter, J.“The Optimal Dynamic Investment Policy for a Fund Manager Compensated with an Incentive Fee.” Journal of Finance, 55 (2000), 2311–2331.CrossRefGoogle Scholar
Chan, L. K. C.; Chen, H.; and Lakonishok, J.. “On Mutual Fund Investment Styles.” Review of Financial Studies, 15 (2002), 1407–1437.Google Scholar
Cohen, R.; Gompers, P.; and Vuolteenaho, T.. “Who Underreacts to Cash-Flow News? Evidence from Trading between Individuals and Institutions.” Journal of Financial Economics, 66 (2002), 409–462.Google Scholar
Cohen, R. B.; Polk, C. K.; and Silli, B.. “Best Ideas.” Working Paper, Harvard University (2010).Google Scholar
Cornell, B., and Roll, R.. “A Delegated-Agent Asset-Pricing Model.” Financial Analysts Journal, 61 (2005), 57–69.Google Scholar
Coval, J. D., and Stafford, E.. “Asset Fire Sales (and Purchases) in Equity Markets.” Journal of Financial Economics, 86 (2007), 479–512.Google Scholar
Cremers, M., and Petajisto, A.. “How Active Is Your Fund Manager? A New Measure That Predicts Performance.” Review of Financial Studies, 22 (2009), 3329–3365.Google Scholar
Cuoco, D., and Kaniel, R.. “Equilibrium Prices in the Presence of Delegated Portfolio Management.” Journal of Financial Economics, 101 (2011), 264–296.Google Scholar
Daniel, K., and Moskowitz, T.. “Momentum Crashes.” Swiss Finance Institute Research Paper No. 13-61; Columbia Business School Research Paper No. 14-6; Fama–Miller Working Paper (2013).Google Scholar
Del Guercio, D.“The Distorting Effect of the Prudent-Man Laws on Institutional Equity Investments.” Journal of Financial Economics, 40 (1996), 31–62.CrossRefGoogle Scholar
DeVault, L.; Sias, R.; and Starks, L.. “Who Are the Sentiment Traders? Evidence from the Cross-Section of Stock Returns and Demand.” Working Paper, University of Arizona and University of Texas (2014).Google Scholar
Edelen, R. M.; Ince, O. S.; and Kadlec, G. B.. “Institutional Investors and Stock Return Anomalies.” Working Paper, University of California at Davis and Virginia Tech (2014).Google Scholar
Edmans, A.; Goldstein, I.; and Jiang, W.. “The Real Effects of Financial Markets: The Impact of Prices on Takeovers.” Journal of Finance, 67 (2012), 933–971.Google Scholar
Falkenstein, E.“Preferences for Stock Characteristics as Revealed by Mutual Fund Portfolio Holdings.” Journal of Finance, 51 (1996), 111–136.Google Scholar
Fama, E., and French, K.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.Google Scholar
Fama, E., and MacBeth, J.. “Risk, Return and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607–636.CrossRefGoogle Scholar
Goldman, E., and Slezak, S.. “Delegated Portfolio Management and Rational Prolonged Mispricing.” Journal of Finance, 58 (2003), 283–311.Google Scholar
Gompers, P., and Metrick, A.. “Institutional Investors and Equity Prices.” Quarterly Journal of Economics, 116 (2001), 229–260.Google Scholar
Hirshleifer, D.; Myers, J.; Myers, L.; and Teoh, S. H.. “Do Individual Investors Cause Post-Earnings Announcement Drift? Direct Evidence from Personal Trades.” Accounting Review, 83 (2008), 1521–1550.Google Scholar
Hong, H., and Stein, J. C.. “A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets.” Journal of Finance, 54 (1999), 2143–2184.Google Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 65–91.CrossRefGoogle Scholar
Jiang, H.; Verbeek, M.; and Wang, Y.. “Information Content When Mutual Funds Deviate from Benchmarks.” Management Science, 60 (2014), 2038–2053.CrossRefGoogle Scholar
Khan, M.; Kogan, L.; and Serafeim, G.. “Mutual Fund Trading Pressure: Firm-Level Stock Price Impact and Timing of SEOs.” Journal of Finance, 67 (2012), 1371–1395.Google Scholar
Lakonishok, J.; Shleifer, A.; and Vishny, R. W.. “The Impact of Institutional Trading on Stock Prices.” Journal of Financial Economics, 32 (1992), 23–44.Google Scholar
Lakonishok, J.; Shleifer, A.; and Vishny, R. W.. “What Do Money Managers Do?” Working Paper, Harvard University (1997).Google Scholar
Lewellen, J.“Institutional Investors and the Limits of Arbitrage.” Journal of Financial Economics, 102 (2011), 62–80.Google Scholar
Maug, E., and Naik, N.. “Herding and Delegated Portfolio Management: The Impact of Relative Performance Evaluation on Asset Allocation.” Quarterly Journal of Finance, 1 (2011), 265–292.Google Scholar
O’Barr, W. M., and Conley, J. M.. Fortune and Folly: The Wealth and Power of Institutional Investing. Homewood, IL: Business One Irwin (1992).Google Scholar
Roll, R.“A Mean/Variance Analysis of Tracking Error.” Journal of Portfolio Management, 18 (1992), 13–22.Google Scholar
Wermers, R.; Yao, T.; and Zhao, J.. “Forecasting Stock Returns through an Efficient Aggregation of Mutual Fund Holdings.” Review of Financial Studies, 25 (2012), 3490–3529.Google Scholar
Supplementary material: File

Cao supplementary material

Cao supplementary material

Download Cao supplementary material(File)
File 332.9 KB