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Why Do Institutional Investors Chase Return Trends?

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  • Alt, Aydogan
  • Kaniel, Ron
  • Yoeli, Uzi
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    Abstract

    We 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 Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8773.

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    Date of creation: Jan 2012
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    Handle: RePEc:cpr:ceprdp:8773

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    Keywords: Institutional Investors; momentum; mutual funds; return trends;

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    Cited by:
    1. Bicchetti, David & Maystre, Nicolas, 2012. "The synchronized and long-lasting structural change on commodity markets: evidence from high frequency data," MPRA Paper 37486, University Library of Munich, Germany.
    2. Dutt, Tanuj & Humphery-Jenner, Mark, 2013. "Stock return volatility, operating performance and stock returns: International evidence on drivers of the ‘low volatility’ anomaly," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 999-1017.

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