The Role of Institutional Investors and Individual Investors in Financial Markets: Evidence from Closed-End Funds

Abstract

I use closed-end funds as a unique research tool to explore whether institutional investors are a stabilizing or a destabilizing force in financial markets. If institutional investors stabilize the market by driving prices towards fundamental values, then they should purchase closed-end funds selling at a wide discount and sell funds selling at a large premium. Consistent with the market-stabilizer hypothesis, I document that wide-discount funds experience a higher subsequent institutional demand than premium funds do. Moreover, my findings that an increase in institutional ownership forecasts a decrease in the volatility of discount returns support the proposition that institutional trading reduces noise trader risk. In sum, the results suggest that institutional investors play a price-stabilizing role in financial markets.