Institutional Investors and Information Acquisition: Implications for Asset Prices and Informational Efficiency

Abstract

Institutional investors nowadays account for a majority of the transactions and equity ownership. In this paper, we develop an asset pricing model with endogenous information acquisition that explicitly incorporates the incentives of institutions. This allows us to jointly determine equilibrium information and portfolio choices as well as resulting asset prices. We show that institutional investors’ portfolios are less sensitive to private information. Thus, they value private information less and, consequently, acquire less of it. An increase in the fraction of institutional investors is accompanied by a decline in price informativeness which can induce a decline in stock price. Moreover, an increase in institutional ownership leads to higher return volatility and a lower Sharpe ratio.