Institutional Investors’ Trading Response to Stock Market Anomalies: Evidence from Korea

Abstract

This study examines whether institutions are sophisticated investors that exploit stock characteristics known to predict future returns in Korea, using data from 2000 to 2018. We analyze the institutional demand, measured as a change in institutional ownership, for stocks with eight well-known anomalies as well as the future abnormal returns of institutional trading. We find that, generally, institutions do not trade consistently with stock anomaly predictions because they are reluctant to hold both highly overvalued and highly undervalued stocks. Although they use a few anomalies, they use these characteristics passively to avoid stocks known to underperform rather than to pick stocks known to outperform. Furthermore, the positive returns on long-legs are concentrated on stocks sold by institutions, while the negative returns on short-legs are concentrated on stocks bought by them. Our finding casts doubt on the widely-accepted notion that institutions are skilled investors and that institutional arbitrage trading corrects any mispricing in the market. To the contrary, institutions’ loss-averse trading behaviors cause or magnify mispricing.

Stock liquidity and stock return: an asymmetric impact of institutional ownership approach

“…Firms with a higher share of the market volume are clearer and it seems logical to invest in stocks of such firms. Furthermore, Kim et al (2020) showed that decisions made by institutional shareholders in firms with a higher market share have more control and monitoring aspects than institutional shareholders of firms with a lower market share. Accordingly, firms in the sample were divided into two groups based on the market value.…”