Institutional investment horizon, herding, and stock returns

Abstract

This thesis investigates the interaction between the herding behavior of institutions classified by their investment horizons and the role of investment horizon of institutions in driving the book-to-market effect. First, we examine the price impact of the herding behavior of short- and long-horizon institutional investors. We categorize the institutional herding as same-side herding when both types of institutions herd on the buy-side or sell-side together and as opposite-side herding when short-horizon institutions buy while the long-horizon institutions sell or vice versa. We find that the previously documented destabilizing impact of long-horizon institutional herding is only observed on opposite-side herding. Moreover, short-horizon institutional herding improves the stock price discovery process confirming the belief that they are more informed. Second, we investigate the differential contribution of institutions with different investment horizons in book-to-market effect. We find that long-horizon institutions tend to buy (sell) stocks with positive (negative) past intangible information. This behavior exacerbates market overreaction and magnifies intangible return reversals and thus contributes to book-to-market effect. On the other hand, short-horizon institutions trade independent of intangible information, and their trading in the direction of intangible information does not contribute to book to market effect. Moreover, our findings also support that short-horizon institutions are better informed than long-horizon institutions.