Skip to main content Accessibility help
×
Home

Institutional Investment Constraints and Stock Prices

  • Jie Cao, Bing Han and Qinghai Wang

Abstract

We test the hypothesis that investment constraints in delegated portfolio management may distort demand for stocks, leading to price underreaction to news and stock return predictability. We find that institutions tend not to buy more of a stock with good news that they already overweight; they are reluctant to sell a stock with bad news that they already underweight. Stocks with good news overweighted by institutions subsequently significantly outperform stocks with bad news underweighted by institutions. The impact of institutional investment constraints sheds new light on asset pricing anomalies such as stock price momentum and post–earnings announcement drift.

    • Send article to Kindle

      To send this article to your Kindle, first ensure no-reply@cambridge.org is added to your Approved Personal Document E-mail List under your Personal Document Settings on the Manage Your Content and Devices page of your Amazon account. Then enter the ‘name’ part of your Kindle email address below. Find out more about sending to your Kindle. Find out more about sending to your Kindle.

      Note you can select to send to either the @free.kindle.com or @kindle.com variations. ‘@free.kindle.com’ emails are free but can only be sent to your device when it is connected to wi-fi. ‘@kindle.com’ emails can be delivered even when you are not connected to wi-fi, but note that service fees apply.

      Find out more about the Kindle Personal Document Service.

      Institutional Investment Constraints and Stock Prices
      Available formats
      ×

      Send article to Dropbox

      To send this article to your Dropbox account, please select one or more formats and confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your <service> account. Find out more about sending content to Dropbox.

      Institutional Investment Constraints and Stock Prices
      Available formats
      ×

      Send article to Google Drive

      To send this article to your Google Drive account, please select one or more formats and confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your <service> account. Find out more about sending content to Google Drive.

      Institutional Investment Constraints and Stock Prices
      Available formats
      ×

Copyright

Corresponding author

* Cao, jiecao@cuhk.edu.hk, Business School, Chinese University of Hong Kong; Han (corresponding author), bing.han@rotman.utoronto.ca, Rotman School of Management, University of Toronto, and Shanghai Advanced Institute of Finance, Shanghai Jiao Tong University; and Wang, qinghai.wang@ucf.edu, College of Business Administration, University of Central Florida.

Footnotes

Hide All
1

We thank Stephen Brown (the editor), Aydogan Alti, Michael Brennan, John Griffin, Jean Helwege, David Hirshleifer, Kewei Hou, Jennifer Huang, Hao Jiang (the referee), Jonathan Lewellen, Stefan Nagel, Laura Starks, Rene Stulz, Michael Stutzer, Siew-Hong Teoh, Sheridan Titman, Ralph Walkling, Russ Wermers, Lu Zheng, and seminar participants at the Hong Kong University of Science and Technology, Peking University, Ohio State University, the University of Texas at Austin, the 2007 Financial Management Association Meetings, and the 2005 Western Finance Association Meetings for helpful discussions and comments. All remaining errors are our own. The work described in this paper was partially supported by a grant from the Research Grant Council of the Hong Kong Special Administrative Region, China (Project No. CUHK 458212).

Footnotes

References

Hide All
Alankar, A.; Blaustein, P.; and Scholes, M.. “The Cost of Constraints: Risk Management, Agency Theory and Asset Prices.” Working Paper, Stanford University (2014).
Alexander, G.; Cici, G.; and Gibson, S.. “Does Trade Motivation Matter? An Analysis of Mutual Fund Trades.” Review of Financial Studies, 20 (2007), 125150.
Allen, F.Do Financial Institutions Matter?Journal of Finance, 56 (2001), 11651175.
Almazan, A.; Brown, K. C.; Carlson, M.; and Chapman, D. A.. “Why Constrain Your Mutual Fund Manager?Journal of Financial Economics, 73 (2004), 289321.
Arnott, R.What Risk Matters? A Call for Papers!Financial Analysts Journal, 59 (2003), 68.
Badrinath, S. G.; Gay, G. D.; and Kale, J. R.. “Patterns of Institutional Investment, Prudence, and the Managerial ‘Safety-Net’ Hypothesis.” Journal of Risk and Insurance, 56 (1989), 605629.
Baker, M.; Litov, L.; Wachter, J.; and Wurgler, J.. “Can Mutual Fund Managers Pick Stocks? Evidence from the Trades Prior to Earnings Announcements.” Journal of Financial and Quantitative Analysis, 45 (2010), 11111131.
Barberis, N.; Shleifer, A.; and Vishny, R.. “A Model of Investor Sentiment.” Journal of Financial Economics, 49 (1998), 307343.
Bennett, J.; Sias, R.; and Starks, L.. “Greener Pastures and the Impact of Dynamic Institutional Preferences.” Review of Financial Studies, 16 (2003), 12031239.
Bushee, B., and Noe, C.. “Corporate Disclosure Practices, Institutional Investors, and Stock Return Volatility.” Journal of Accounting Research, 38 (2000), 171202.
Cai, F., and Zheng, L.. “Institutional Trading and Stock Returns.” Finance Research Letters, 1 (2004), 178189.
Carpenter, J.The Optimal Dynamic Investment Policy for a Fund Manager Compensated with an Incentive Fee.” Journal of Finance, 55 (2000), 23112331.
Chan, L. K. C.; Chen, H.; and Lakonishok, J.. “On Mutual Fund Investment Styles.” Review of Financial Studies, 15 (2002), 14071437.
Cohen, R.; Gompers, P.; and Vuolteenaho, T.. “Who Underreacts to Cash-Flow News? Evidence from Trading between Individuals and Institutions.” Journal of Financial Economics, 66 (2002), 409462.
Cohen, R. B.; Polk, C. K.; and Silli, B.. “Best Ideas.” Working Paper, Harvard University (2010).
Cornell, B., and Roll, R.. “A Delegated-Agent Asset-Pricing Model.” Financial Analysts Journal, 61 (2005), 5769.
Coval, J. D., and Stafford, E.. “Asset Fire Sales (and Purchases) in Equity Markets.” Journal of Financial Economics, 86 (2007), 479512.
Cremers, M., and Petajisto, A.. “How Active Is Your Fund Manager? A New Measure That Predicts Performance.” Review of Financial Studies, 22 (2009), 33293365.
Cuoco, D., and Kaniel, R.. “Equilibrium Prices in the Presence of Delegated Portfolio Management.” Journal of Financial Economics, 101 (2011), 264296.
Daniel, K., and Moskowitz, T.. “Momentum Crashes.” Swiss Finance Institute Research Paper No. 13-61; Columbia Business School Research Paper No. 14-6; Fama–Miller Working Paper (2013).
Del Guercio, D.The Distorting Effect of the Prudent-Man Laws on Institutional Equity Investments.” Journal of Financial Economics, 40 (1996), 3162.
DeVault, L.; Sias, R.; and Starks, L.. “Who Are the Sentiment Traders? Evidence from the Cross-Section of Stock Returns and Demand.” Working Paper, University of Arizona and University of Texas (2014).
Edelen, R. M.; Ince, O. S.; and Kadlec, G. B.. “Institutional Investors and Stock Return Anomalies.” Working Paper, University of California at Davis and Virginia Tech (2014).
Edmans, A.; Goldstein, I.; and Jiang, W.. “The Real Effects of Financial Markets: The Impact of Prices on Takeovers.” Journal of Finance, 67 (2012), 933971.
Falkenstein, E.Preferences for Stock Characteristics as Revealed by Mutual Fund Portfolio Holdings.” Journal of Finance, 51 (1996), 111136.
Fama, E., and French, K.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427465.
Fama, E., and MacBeth, J.. “Risk, Return and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607636.
Goldman, E., and Slezak, S.. “Delegated Portfolio Management and Rational Prolonged Mispricing.” Journal of Finance, 58 (2003), 283311.
Gompers, P., and Metrick, A.. “Institutional Investors and Equity Prices.” Quarterly Journal of Economics, 116 (2001), 229260.
Hirshleifer, D.; Myers, J.; Myers, L.; and Teoh, S. H.. “Do Individual Investors Cause Post-Earnings Announcement Drift? Direct Evidence from Personal Trades.” Accounting Review, 83 (2008), 15211550.
Hong, H., and Stein, J. C.. “A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets.” Journal of Finance, 54 (1999), 21432184.
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 6591.
Jiang, H.; Verbeek, M.; and Wang, Y.. “Information Content When Mutual Funds Deviate from Benchmarks.” Management Science, 60 (2014), 20382053.
Khan, M.; Kogan, L.; and Serafeim, G.. “Mutual Fund Trading Pressure: Firm-Level Stock Price Impact and Timing of SEOs.” Journal of Finance, 67 (2012), 13711395.
Lakonishok, J.; Shleifer, A.; and Vishny, R. W.. “The Impact of Institutional Trading on Stock Prices.” Journal of Financial Economics, 32 (1992), 2344.
Lakonishok, J.; Shleifer, A.; and Vishny, R. W.. “What Do Money Managers Do?” Working Paper, Harvard University (1997).
Lewellen, J.Institutional Investors and the Limits of Arbitrage.” Journal of Financial Economics, 102 (2011), 6280.
Maug, E., and Naik, N.. “Herding and Delegated Portfolio Management: The Impact of Relative Performance Evaluation on Asset Allocation.” Quarterly Journal of Finance, 1 (2011), 265292.
O’Barr, W. M., and Conley, J. M.. Fortune and Folly: The Wealth and Power of Institutional Investing. Homewood, IL: Business One Irwin (1992).
Roll, R.A Mean/Variance Analysis of Tracking Error.” Journal of Portfolio Management, 18 (1992), 1322.
Wermers, R.; Yao, T.; and Zhao, J.. “Forecasting Stock Returns through an Efficient Aggregation of Mutual Fund Holdings.” Review of Financial Studies, 25 (2012), 34903529.

Related content

Powered by UNSILO
Type Description Title
UNKNOWN
Supplementary materials

Cao supplementary material
Cao supplementary material

 Unknown (333 KB)
333 KB

Institutional Investment Constraints and Stock Prices

  • Jie Cao, Bing Han and Qinghai Wang

Metrics

Full text views

Total number of HTML views: 0
Total number of PDF views: 0 *
Loading metrics...

Abstract views

Total abstract views: 0 *
Loading metrics...

* Views captured on Cambridge Core between <date>. This data will be updated every 24 hours.

Usage data cannot currently be displayed.