Working Paper: NBER ID: w22161
Authors: Zhi Da; Borja Larrain; Clemens Sialm; Jos Tessada
Abstract: We document a novel channel through which coordinated noise trading exerts externalities on financial markets dominated by institutional investors. We exploit a unique set of events where Chilean pension fund investors followed an influential financial advisory firm that recommended frequent switches between equity and bond funds. The recommendations, which mostly followed short-term trends, generated large and coordinated fund flows. These flows resulted in substantial price pressure and increased volatility in financial markets. Pension funds increased cash holdings as a response. Our findings suggest that giving retirement savers unconstrained reallocation opportunities may exert negative externalities on financial markets.
Keywords: coordinated noise trading; pension funds; financial markets; price pressure; volatility
JEL Codes: F32; G02; G11; G12; G14; G15; G18; G23; G28; H31; H55
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| noise trading (C58) | influence on asset prices even when institutional investors dominate ownership (G19) |
| larger stocks (G10) | greater price pressure due to reallocations (L11) |
| stocks with higher portfolio weights relative to their market capitalization (G11) | increased volatility and price pressure (E39) |
| coordinated noise trading through pension fund reallocations (G23) | substantial price pressure in the Chilean equity market (G19) |
| fund reallocations (G59) | market prices (P22) |