Ebook Dynamics Between Equity Holdings and Returns
In this paper, we aim to contribute to the understanding of the causal relation between institutional equity holdings and returns. Since movements in stock prices are caused by investors’ trading decisions, the characteristics of the investors making these trading decisions would be expected to have an impact on stock prices. There is a growing body of literature that seeks to document and explain the linkages between changes in the holdings of different investor classes and stock price movements. However, such studies have generally been hampered by a lack of precision in the available data. This paper examines the relation between equity holdings and returns using a unique dataset from the Helsinki Stock Exchange (HEX). Similar to Griffen, Harris and Topaloglu (2003), we study the interaction between equity returns and changes in ownership structure. Specifically, the primary objective of this study is to determine the direction of causality between these two variables of interest down to intra-day accuracy, and thus help resolve contradictions in prior research. We separately analyze each of the three following investor classes: foreign institutions, domestic institutions and retail traders. A secondary research issue addressed in this study is the herd behavior within each of these classes, that is, the propensity of investors to trade in the same direction.
In recent years there has been a significant growth in the presence of institutional traders in equity markets. Consequently, the bulk of extant research is focused on institutional trading. In particular, the positive correlation between institutional trading activity and stock returns is well documented in the literature. For instance, in an early study, Klemkosky (1977) examines the impact of net institutional ownership changes on returns in the surrounding months, and finds a contemporaneous relation. More recently, Nofsinger and Sias (1999) report that, for their sample of NYSE-listed securities, there is a positive correlation between the two variables of interest, but the direction of “causation remains ambiguous”. In other words, we are faced with the question of whether stock price movements drive institutional trading decisions, or vice versa. The former is commonly attributed to herding behavior, that is, certain trader classes responding in the same manner to signals. Herding in response to prior returns is known as “feedback trading,” which can be positive or negative depending on the direction of trade (see, among others, DeLong, Shleifer, Summers, & Waldman, 1990; Hong & Stein, 1999). For instance, Lakonishok, Schleifer and Vishny (1992) examine the quarterly holdings for a large sample of pension funds, and report that such institutional investors do not trade in response to price changes.
Grinblatt, Titman and Wermers (1995) and Cai, Kaul and Zheng (2000) also analyze quarterly holdings data, but find that institutional investors employ momentum-based trading strategies. In other words, they positive feedback trade. Furthermore, this causal relationship is uni-directional, with trading activity having no impact on future price movements.
An alternative explanation for co-movements between equity holdings and returns is that certain market participants are relatively more informed, and thus influence future prices via their trades (see Glosten & Milgrom, 1985; Ke & Petroni, 2004, among others). Daniel, Grinblatt, Titman and Wermers (1997), for example, study the performance of several mutual fund portfolios over a 30-year timeframe. The findings indicate that sample fund managers are able to anticipate security price movements at least some of the time (See Chen, Jegadeesh, & Wermers, 2000; Grinblatt & Titman, 1993; Pinnuck, 2003; Wermers, 2000, among others). However, Pinnuck (2003) cautions that such findings may be driven by price pressure from institutional trading, rather than any informational effect. This may occur, for example, when there is large net institutional activity on one side of the market. Due to the demand for liquidity, prices in the contemporaneous or immediately subsequent periods may increase even in the absence of any private information. Indeed, in their investigation of quarterly institutional holdings and net trading activity, Gompers and Metrick (2001) document findings that strongly reject both the “feedback trade” and “informed trading” hypotheses in favor of the explanation that institutional trading activity exacts pressure on equity prices. Also, in contrast to many of the studies discussed above, other researchers have reported empirical evidence suggesting that causality is bi-directional, that is, both feedback trade and information/price pressure play a role in explaining the relation between the two variables of interest (for example, see Dennis & Strickland, 2002; Grinblatt & Keloharju, 2000; Sias, Starks, & Titman, 2001) .
Thus, although much research interest has been focused on this area, results from extant papers are not uniform. It is plausible that this might be due to the data constraints that have largely limited analyses to quarterly ownership data from the U.S. markets. Accordingly, several recent papers have addressed this issue using either improved methodologies or datasets. From quarterly data, Sias, Starks and Titman (2001) employ a methodology which allows them to infer the relation between institutional holdings and returns over more precise time periods. Results indicate bi-directional causality, with price pressure being of greater explanatory importance than informed trading activity. Further, almost all the quarterly covariance is attributable to intraday price changes, but the lack of data precludes any further analyses.
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