INFORMED INSTITUTIONAL INVESTORS' TRADES AND HEDGE FUNDS ROLE IN THE FINANCIAL MARKETS
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My dissertation consists of two essays regarding institutional investor trading behavior. The first paper, "Are Institutional Investors Informed? Evidence from Entry, Exit, and Adjustments," focuses on a novel approach to identify the informational content of institutional investors' trades. Most previous research fails to find a consistent relation between measures of aggregate institutional investor demand and subsequent returns. In this paper I propose that disaggregated institutional demand will better capture informed institutional trading than aggregated institutional demand. Specifically, I hypothesize that: (1) institutional entry and exit trades are more likely to be informed, while adjustments to existing positions are more likely to be liquidity-motivated, (2) institutional sales are more likely to be informed than institutional purchases, and as a result, (3) disaggregated institutional demand (i.e., jointly considering entry, increases to existing positions, decreases to existing positions and exit trades) will better forecast subsequent returns than aggregate institutional demand. My empirical results support all three hypotheses.The second study, titled "Hedge Fund Herding," investigates herding behavior by hedge funds. The popular press and conventional wisdom holds that hedge funds trade excessively, engage in herding, and, as a result, destabilize markets. Using a unique proprietary dataset, we examine hedge fund herding. Our empirical results demonstrate that hedge funds' role in the market has dramatically increased over time and hedge funds are more active traders than other institutional investors. Moreover, we find evidence of strong correlation between both hedge fund and non-hedge fund demand and contemporaneous returns, consistent with the notion that both groups are driving stock returns. Inconsistent with conventional wisdom, we also find that hedge funds are less likely to engage in herding than other institutional investors. In addition, although herding by non-hedge fund institutions appears to destabilize asset prices, herding by hedge funds push prices towards equilibrium. Our results are inconsistent with the notion that hedge funds' herd more than other institutions and drive prices from fundamentals.