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Institutional investors and the limits of arbitrage

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  • Lewellen, Jonathan

Abstract

The returns and stock holdings of institutional investors from 1980 to 2007 provide little evidence of stock-picking skill. Institutions as a whole closely mimic the market portfolio, with pre-cost returns that have nearly perfect correlation with the value-weighted index and an insignificant CAPM alpha of 0.08% quarterly. Institutions also show little tendency to bet on any of the main characteristics known to predict stock returns, such as book-to-market, momentum, or accruals. While particular groups of institutions have modest stock-picking skill relative to the CAPM, their performance is almost entirely explained by the book-to-market and momentum effects in returns. Further, no group holds a portfolio that deviates efficiently from the market portfolio.

Suggested Citation

  • Lewellen, Jonathan, 2011. "Institutional investors and the limits of arbitrage," Journal of Financial Economics, Elsevier, vol. 102(1), pages 62-80, October.
    • Handle: RePEc:eee:jfinec:v:102:y:2011:i:1:p:62-80
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