Trading Opportunities and the Portfolio Choice of Institutional Investors

Abstract

This paper studies the portfolio choice of institutional investors with short holding horizons. Short-horizon institutions invest more in stocks with lower buy-and-hold return and worse liquidity comparing to other institutional investors. I explain this phenomenon in a model where short-horizon institutions can routinely profit from temporary mispricing. Stocks that are more susceptible to temporary mispricing attract more demand from short-horizon institutions, which reduces long-term stock return and drives out demand from other investors. Empirically, I find that stocks more held by short-horizon institutions provide more short-term trading opportunities, allowing short-horizon institutions to make more trading profit, as my model predicts.