Introduction
Doinstitutionalinvestors,presumablysophisticatedones,makeassetpriceslessvolatileandmore informativeorthereverse?Thegrowingroleofinstitutionalinvestorsinthepastdecadewarrants moreeortstoanswerthisquestion.Therelationshipbetweeninstitutionalownershipandvolatility hasbeeninvestigatedempiricallybySias(1996)andbroadimplicationsofownershippatternson nancialmarketshasbeendiscussedinFriedman(1996).Theobjectiveofthispaperistoanalyze theeectofinstitutionalinvestorsonthemarketpricebyusingatheoreticalframeworkand assumingthoseinvestorsaremoresophisticatedthanindividualinvestors,insofarastheformeruse theequilibriumpricetoextractinformationwhilethelatterdonot. UsingthesecuritieslistedontheNewYorkStockExchangebetween1977and1991,andcontrol- lingforcapitalization,Sias(1996)ndsapositiverelationshipbetweenthefractionofsharesheld byinstitutionalinvestorsandthevolatilityofthestockreturns
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andpresentsevidencethatthein- creaseintheshareofinstitutionalownershipprecedestheincreaseinvolatility,notthereverse.Sias alsopointstotheapparentinconsistencybetweenthisevidenceandmostoftheextantliterature, fromwhichhequotesthreeargumentsimplyinganegativerelationshipbetweenvolatilityandinsti- tutionalownership.First,fundmanagersmayshyawayfromriskierstocksforprudentialreasons (e.g.topreventlawsuits).Second,institutionalinvestors,beingabletoinvestmoreinresearch, havemoreandbetterinformationaboutthecompaniesintheirportfolio.Third,institutionalin- vestorsshouldbemorelikelytobehaverationally.
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Inthispaper,wearguethatitispreciselythe institutionalinvestors'abilitytorationallyusealltheavailableinformation|includingthemarket price|thatinducesahigherpricevolatility(andalowerpriceinformativeness)inthestocksthey dominate.Friedman(1996)discussesaseriesofimplicationsofthegrowingweightofinstitutional ownershipontheproperworkingsofthenancialmarkets.Henotesthattheincreasingconcentra- tionofdecision-makingcouldrenderthemarketpricemoresensitivetoeachinvestor'sidiosyncratic shocks,whichwouldtranslateintoincreasedvolatility.Mymodelinvestigateswhetheranincrease inthenumberofinstitutionalinvestorsosetsthiseect. Therelationshipbetweeninstitutionalownershipandthevolatilityandtheinformativenessof
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Withoutcontrollingforcapitalization,institutionalinvestors'ownershipandstockreturnvolatilityarenegatively correlatedbecauseinstitutionalinvestorstendtoholdstockswithlargecapitalizationandthelattertendtobeless volatile.
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Siasalsocitessomeargumentsthatcouldleadtotheoppositeconclusion,liketheasymmetryinincentivesfor thefundmanager.
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