Daily Academic Alpha: Analyzing the Effects of Long-Term vs. Short-Term Investors

Daily Academic Alpha: Analyzing the Effects of Long-Term vs. Short-Term Investors

July 14, 2015 $brk-a
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(Last Updated On: January 18, 2017)

Through the traditional lens of the efficient market hypothesis, market prices stick close to their fundamental values because professional investors with large amounts of capital counteract mispricings created by “dumb” or “retail” investors. For example, if Dan the DayTrader enters sell orders on stock ABC at $8, when it is worth $10, Peter the Professional swoops in and purchases all the sell orders until stock ABC moves back up to $10. In the end, market prices are efficient, Dan the DayTrader loses money, and Peter the Professional has served his role as the “smart” money.

All a great story. But what does Peter the Professional really do in practice?

A while ago we mentioned a recent research piece that spotlighted an interesting phenomenon: institutional investors don’t correct anomalous contribute to stock return anomalies!

A more recent paper highlights that some professionals do serve as agents of market efficiency, but others actually create mispricings!

Institutional Investor Type and Misvaluation

We find that institutional investor types have distinct effects on the perceived value of the firm. Dedicated long-term institutional investors decrease future firm misvaluation relative to fundamentals, as well as the volatility of firm returns. Transient short-term institutional investors, in contrast, increase future firm misvaluation and volatility of firm returns. This result implies a more nuanced relationship of institutional ownership with firm value and corporate governance.


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Definitions of common statistics used in our analysis are available here (towards the bottom)

About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.

  • Mark

    Hi Wes, thanks for the post! I know this question is irrelevant to this post, and will be deeply appreciated if you can help point out. Anyway, I was wondering if you have ever seen any literature in regards to household financial asset allocation and the asset’s future returns? If so, can you help point it out ?Thanks very much!!

  • I don’t know of any academic research off hand.
    You may want to google “amir sufi.” He’s one of my old advisors at Chicago and used to write stuff vaguely related.

  • Mark

    Thanks all the same! The reason I asked is that I have come across a graph, which shows household Equity allocation as a percentage of total households financial assets and the 10-year equity return. There is a very strong correlation between the two, but I was trying to understand if there is a causality behind the two? Do you have any thoughts ? Thanks

  • my instinct would be noise…but I’d have to investigate thoroughly to really get a sense

  • Michael Milburn

    Mark, philosophical economics blog did a writeup on this topic that I thought was good.


  • jimhsu

    Would it make sense for firms with higher long-term investors to be “better” value stocks, and higher short-term participation to be “better” momentum stocks?

  • Jack Vogel, PhD

    Interesting idea, maybe someone will write a paper on the topic.