Connected Stocks

Abstract

We connect stocks through their common active mutual fund owners. We show that the degree of shared ownership forecasts cross-sectional variation in return correlation, controlling for exposure to systematic return factors, style and sector similarity, and many other pair characteristics. We argue that shared ownership causes this excess comovement based on evidence from a natural experiment-the 2003 mutual fund trading scandal. These results motivate a novel cross-stock-reversal trading strategy exploiting information contained in ownership connections. We show that long-short hedge fund index returns covary negatively with this strategy, suggesting these funds may exacerbate this excess comovement. Barberis and Shleifer (2003) and Barberis, Shleifer, and Wurgler (2005) argue that institutional features may play an important role in the movement of stocks' discount rates, causing returns to comove above and beyond the comovement implied by their fundamentals. In this paper, we propose a new approach to document that type of institutional-based comovement. Based on mounting evidence since Coval and Stafford (2007) that mutual fund flows result in price pressure, we focus on connecting stocks through active mutual fund ownership. Specifically, we forecast cross-sectional variation in return correlation for stock pairs using the degree of common ownership by active mutual funds. Our bottom-up approach allows us to measure institutional-driven comove-

An Institutional Theory of Momentum and Reversal

“…Coval and Stafford (2007) find that mutual funds experiencing large outflows engage in distressed selling of their stock portfolios. Anton and Polk (2008) show that comovement between stocks is larger when these are held by many mutual funds in common, controlling for style characteristics. Lou (2008) predicts flows into mutual funds by the funds' past performance, and imputes flows into individual stocks according to stocks' weight in funds' portfolios.…”

Reputational Concerns and Price Comovements

“…In other words, the uninformed managers must be indifferent between all assets whose value is not revealed and the risk-free asset. Furthermore, point (1) …”

“…In equilibrium, when χ = (0, 0) a fraction α of informed traders demand asset 1 and a fraction β demand asset 2, with α ∈ [0, 1], β ∈ [0, 1] and α + β ∈ [1,2]. The value f is the conditional probability of failure for an asset when the realized price pair is (p, p) and it depends on α and β.…”

“…Barberis and Shleifer [2], Barberis, Shleifer and Wurgler [3], Coval and Stafford [7], and Antón and Polk [1]). This tendency to comove has been explained in two different ways.…”

The role of internet in stock market

“…Anton and Polk (2014) show that shared ownership in mutual fund can explain the observed excess comovement. In that sense, we construct the number of trade (NUMofII) and the percentage of trade (PERCofII) by institutional investors as proxies for the institutional trading.…”