Hedge Fund Redemption Restrictions and Stock Price Fragility

Abstract

This paper explores the idea that the increasing concentration of institutional ownership in equity markets makes stock prices more "fragile," i.e., more exposed to liquidity shocks to institutional investors. I argue that institutional stockholders with stricter redemption policies, who are less likely to experience redemption-generated liquidity shocks, should expose stocks to lower levels of price fragility. An analysis of hedge fund characteristics confirms that hedge funds with strict redemption policies exhibit less portfolio turnover, and stocks held by high-restriction funds are less exposed to flow-induced liquidity trading. A hand-collected dataset of institutional block acquisitions reveals comparatively higher cumulative abnormal returns following block acquisitions by hedge funds with tighter redemption restrictions, confirming that the market places a value on strict redemption policies. Finally, a difference-in-differences regression reveals that stocks purchased by institutional blockholders with stricter redemption policies experience a significant decrease in volatility.