Stock ownership by institutional investors cause higher stock price volatility, inefficiency and fragility, study finds

According to a recent study, institutional investors, among which BlackRock, Vanguard, Fidelity, JPMorgan, are responsible for increasing price volatility and mispricing in company stocks. Moreover, stocks with higher ownership by such investors show greater price drops during periods of market turmoil. The findings of this study provide implications for the regulatory system, adding to the debate on the optimal size of asset management firms.

A study by four finance professors, Itzhak Ben-David, Francesco Franzoni, Rabih Moussawi and John Sedunov (June, 2020), has found evidence that the 10 larger institutional investors’ trading activities are responsible for increasing stock price volatility and mispricing in company stocks. In relation to this, the study shows that stocks with higher ownership by such investors show greater price drops during periods of market turmoil, when institutional investors engage in extensive divestments which consequently lead to depressed stock prices.

Since 1980, the top 10 institutional investors have increased fourfold their investments in the US stocks, reaching in 2016 a cumulative holding of the 26.5% of the market. Among these institutional investors we find BlackRock, Vanguard, Fidelity, JPMorgan.

The authors of the study have also investigated the channels behind these effects. Empirical evidence supports the reasoning that top institutions are granular, meaning that capital flow and trading strategies are more correlated across divisions within the same institution than across smaller independent traders. The authors interpret this finding as the result of centralized functions and corporate identity which influence and lead to “family-wide” investment decisions, as well as a result of cross-selling practices.

By analyzing the daily return autocorrelation, the authors also found that stocks largely held by those large institutions show more negatively autocorrelated returns. Such finding is consistent with the theory that “large investors impound liquidity shocks into prices, which then revert, and lead to noisier prices”.

These discoveries are in contrast with BlackRock’s statement that the growth in trading has positively affected the efficiency of stock price discovery, and have been rejected by Vanguard which affirmed that none of its internal studies have found such a relationship between volatility and trading volume growth.

The findings of this study provide implications for the regulatory system, adding to the debate on the optimal size of asset management firms. In this regard, the authors conclude that: “[…] combining different institutions within a unique conglomerate affects the “production function” of all the entities involved. Access to capital as well as the investment and trading activities of the various components within a conglomerate display a higher correlation than is the case for independent firms. This correlated behavior, combined with the sheer size of the conglomerates, has repercussions on asset price stability that are mostly felt during times of market stress. This last consideration in particular supports the regulatory concerns, and it suggests that excessive concentration in the asset management industry may pose a systemic risk. Of course, any regulatory action should weigh the decrease in price efficiency and the increased potential of large price drops against the economies scale in information production and trading that large institutions can achieve and can pass on to their clients“.

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