Who is a Winner in Volatile Markets? Evidence from Chinese Funds

Abstract

The proliferation of institutions has drawn an attention in the financial economists' interest on the effect of institutional trading on market volatility for a few decades. Existing research on institutional investors, however, has not considered separating a bull market from a bear market, an important macroeconomic factor, in studying the role of institutional trading in market volatility. In addition, few studies have focused on emerging markets in developing countries. Particularly, who can identify the change in macroeconomic fundamentals, make more rational decisions, and eventually dominate the Chinese emerging stock market, institutions or individuals? Addressing this gap, this study examines the impact of institutional trading on the Chinese emerging volatile markets, from bearish markets (2001-2003) to bullish markets (2004-2006), effectively integrating the institutional (de)stabilizing effect into a more completely developed perceptive. In particular, we investigate the relationship between the level of institutional ownership and a firm's abnormal returns on large market movement days. We find that institutions are able to make quicker and more rational adjustments in their trading strategies as compared to the delayed market reactions due to a change in macroeconomic trend and a supervising regulatory policy issued at the beginning of 2004. Institutions use different trading strategies from bearish markets (2001-2003) to bullish markets (2004-2006), on large market movement days, such as selling against a rising market in bearish markets while continually pushing the entire stock index up in bullish markets. Moreover, institutions successfully predict the tendency of future stock market although the Chinese stock market is more volatile than others. Meanwhile, we find that institutions buy (sell) less than individuals on large price swing days, consistent with the notion that institutions are more rational than individuals in emerging markets. Further, systematic risk in the Chinese stock market is twenty-four times than that in US, reflecting a significant difference between an emerging market and a developed market. Overall, these results indicate that institutions become a winner in the Chinese stock market.