Working Paper: CEPR ID: DP8773
Authors: Aydogan Alt; Ron Kaniel; Uzi Yoeli
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.
Keywords: Institutional Investors; Momentum; Mutual Funds; Return Trends
JEL Codes: G11; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Low information quality (L15) | Institutional investors chase trends (G23) |
| Uncertainty regarding precision of private information (D89) | Delay in purchases until confirming good news (G14) |
| Confirming good news (Y60) | Increase in expectations of future returns (D84) |
| Good news (Y60) | Confirmation effect increases confidence (C92) |
| Good news (Y60) | Convergence effect increases stock prices (F62) |
| Low information quality (L15) | Less likely to initiate positions in past loss makers (G41) |
| Low information quality (L15) | More likely to purchase recent winners (D44) |
| Modestly positive recent stock price run-ups (G19) | More pronounced trend chasing behavior (C92) |
| Past experience fades over time (C41) | Trend chasing behavior contingent on information quality (D83) |