Institutional Ownership, Retail Trading and Stock Return Comovement

Abstract

Using mutual fund fire sales to proxy for an exogenous demand shock on institutional ownership, I show that fire sale stocks start to comove more with low institutional ownership stocks and comove less with high institutional ownership stocks. Moreover, the cumulative change in return comovement is driven by retail trading, especially for stocks favored by or familiar to retail investors, such as small stocks with low price, high turnover, more analyst coverage, and held by domestic mutual funds. In addition, the short-term price impact of institutional selling is absorbed by retail buying when investor sentiment is high, and in the long run retail investors provide liquidity to institutional trading when market liquidity is low. Across time, the institutional ownership-based return comovement is amplified during periods of high market sentiment, market declines and high market volatility. The overall results suggest that the institutional ownership-based excess return comovement is explained by category investment or clientele effect.