Why Do Institutional Investors Chase Return Trends?
AbstractWe propose and test a simple explanation for institutional investors’ tendency to chase return trends. When investors face uncertainty about the precision of their private information, they wait for subsequent confirming news before establishing stock positions. While such news impact the stock price, at the same time they increase investors’ estimates of the precision of their information. With low information quality the latter effect dominates and causes investors to purchase the stock after confirming good news. We formalize these ideas in a simple model and test the model’s predictions on mutual funds’ stock holdings data. Using mutual funds’ past return experiences with individual stocks as a proxy for their stock-specific information quality, we find evidence for the prediction that trend chasing is more likely when information quality is low.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8773.
Date of creation: Jan 2012
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Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G20 - Financial Economics - - Financial Institutions and Services - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-03-28 (All new papers)
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