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Playing the Market: Turnover of Institutional Ownership and Stock Returns PowerPoint PPT Presentation

Playing the Market: Turnover of Institutional Ownership and Stock Returns Valentin Dimitrov Rutgers University Vladimir Gatchev UCF February 5, 2010 Institutional Investors Institutional investors play a dominant role in U.S. equity markets

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Playing the market turnover of institutional ownership and stock returns l.jpg

Playing the Market:Turnover of Institutional Ownership and Stock Returns

Valentin Dimitrov

Rutgers University

Vladimir Gatchev

UCF

February 5, 2010


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Institutional Investors

  • Institutional investors play a dominant role in U.S. equity markets

    • According to the Conference Board, in 2006 the market value of total institutional equity holdings was $12.9 trillion, accounting for 66.3% of total equity

  • Institutions are active traders

    • Boehmer and Kelley (2009) report that institutional investors account for the majority of trading volume on NYSE

    • We find that institutional investors turn over 37% of their ownership per quarter

    • There is substantial variation in institutional turnover rates across stocks (0% to 100% per quarter)


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Motivation

  • What are the implications of turnover rates by institutions for stock prices?

  • Share turnover rates and disagreement

    • Karpoff (1986)

    • Harris and Raviv (1993)

  • Disagreement and stock valuation

    • Miller (1977)

  • A more comprehensive theory

    • Harrison and Kreps (1978)

    • Scheinkman and Xiong (2003)


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Scheinkman and Xiong (2003)

  • Two classes of investors disagree about fundamentals

  • The relative valuations of the two classes fluctuate over time

  • When valuations cross, the optimists buy the shares from the pessimists, leading to share turnover

  • With short-sales constraints, share ownership comes with an option to sell to more optimistic investors

  • Share prices include a premium for the option to sell

    • Investors buying the shares pay that premium

    • Investors selling the shares require that premium

  • In equilibrium, higher turnover rates are accompanied by a higher premium in prices – investors “Pay to Play”


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Do Institutions Pay to Play?

  • Is high turnover of ownership by institutions associated with a premium in stock prices?

    • If, on average, institutions expect to profit from trading, a premium in prices may exist

  • Would institutions’ expectations of trading profits depend on who they trade with?

    • Individuals

      • Commonly held view is that individuals are less informed that institutions

      • If institutions hold that view, they will expect to make profits when trading with individuals

    • Other institutions

      • If institutions believe that other institutions are also well informed, then they may not expect to make profits from trading with other institutions


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Hypotheses

  • Turnover of institutional ownership is negatively related to future stock returns

  • The negative relation between turnover of institutional ownership and future stock returns is:

    • More pronounced when turnover is due to trading of institutions and individuals than when turnover is due to trading among institutions

  • The negative relation between turnover of institutional ownership and future stock returns is more pronounced for firms in which differences of opinion are more likely to be high:

    • High return volatility stocks

    • High total trading activity stocks

    • High growth opportunities stocks


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Related Literature

  • Institutional ownership

    • Gompers and Metrick (2001)

    • Yan and Zhang (2009)

  • Changes in institutional ownership

    • Nofsinger and Sias (1999)

    • Cohen, Gompers, Vuolteenaho (2002)

    • Cai and Zheng (2004)

    • Campbell, Ramadorai, Schwartz (2009)

  • Institutional herding

    • Wermers (1999)

    • Sias (2004)

    • Dasgupta, Prat, Verardo (2009)

  • Changes in breadth of ownership

    • Chen, Hong, Stein (2002)


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Snapshot of Results (1)

  • Turnover of institutional ownership is negatively related to future returns

  • Based on 10 portfolios, the hedge return for the two extreme portfolios is 8.6%

  • The relation is due to trading of institutions with individuals

  • Robust to controls for size, B/M, past returns, level and change of institutional ownership, return volatility, and overall trading activity


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Snapshot of Results (2)

  • Results are more pronounced for

    • stocks with high overall trading activity

      • 15.0% (vs 2.1%) hedge return

    • stocks with high stock return volatility

      • 10.2% (vs 0.3%) hedge return

    • stocks with low B/M

      • 13.6% (vs 2.5%) hedge return

  • Not subsumed by additional ownership-related variables

    • change in breadth of institutional ownership

    • persistence in institutional buying


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Sample and Turnover Measures

  • Main sample from CDA/Spectrum database

    • Common stocks between 1983:Q4 to 2007:Q4

    • A total of 416,384 observations for an average of 4,293 per quarter

    • A minimum of 3,263 and a maximum of 5,765 stocks per quarter

  • Turnover of institutional ownership

    • Due to total trading (1):

      Absolute value of quarterly change in shares held by each institution, summed up over all institutions, divided by average shares held by all institutions, over the past 8 quarters

    • Due to trading of institutions with individuals (2):

      Absolute value of quarterly change in shares held by all institutions, divided by average shares held by all institutions over the past 8 quarters

    • Due to trading among institutions: (1) minus (2)


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Additional Variables

  • Additional data sources

    • CRSP, Compustat

  • Additional variables

    • Stock returns for the past 24- and 12-months

    • Stock returns for the future 3-, 6-, and 12-months

    • Market capitalization of equity

    • Book-to-market of equity

    • Stock return volatility for the past 24 months

    • Total share turnover for the past 24 months

    • Level of institutional ownership

    • Average change in institutional ownership for the past 8 quarters

    • Change in breadth of ownership (Chen, Hong, and Stein (2002))

    • Persistence in institutional buying (Dasgupta, Prat, Verardo (2009))


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Summary Statistics (1)


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Summary Statistics (2)


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Future 12-month Hedge Returns Based on Total Turnover of Institutional Ownership


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Future 12-month Hedge Returns Based on Turnover of Institutions with Individuals


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Future 12-month Hedge Returns Based on Turnover Among Institutions


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Portfolio Analysis (1)


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Portfolio Analysis (2)


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Portfolio Analysis (3)


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Regression Analysis:Base Specification


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Regression Analysis:Additional Controls (1)


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Regression Analysis:Additional Controls (2)


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Conditional Portfolio Analysis (1)


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Conditional Portfolio Analysis (2)


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Conditional Portfolio Analysis (3)


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Conditional Regression Analysis


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Changes in Turnover and Returns


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Institutional Ownership


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Change in Institutional Ownership


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Change in Breadth of Ownership


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Persistence


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Robustness

  • Measuring turnover rates

    • 6 quarters, 4 quarters

    • Dollars vs shares

  • Robust across different time periods

    • 1983-1997; 2000-2007

  • Other controls

    • 8 lags of change in institutional ownership

  • Data selection

    • Winsorizing future returns; truncating variables

    • Using stocks below $1/share


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Conclusions (1)

  • High turnover of institutional ownership is associated with a premium in stock prices

  • The premium is driven by trading of institutions with individuals

  • The premium is more pronounced for:

    • stocks with high stock return volatility

    • stocks with high overall trading activity

    • stocks with low B/M


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Conclusions (2)

  • Results consistent with disagreement-based models

    • Harrison and Kreps (1978)

    • Scheinkman and Xiong (2003)

  • Risk-based explanations?

    • Liquidity?

    • Adverse selection costs?

  • What differences between institutions and individuals drive our findings?

    • Predictable individual investor sentiment

    • Agency issues of institutional investors


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