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UBC Theses and Dissertations

Essays on institutional investors and asset pricing Zhang, Tianyao


In this thesis, I study the asset pricing aspect of institutional investors and their ability to provide financial services to households. The thesis consists of three essays. In the first essay, I theoretically investigate how institutional investors with different holding horizons allocate capital and the related asset pricing implications. I propose a model in which some institutions have shorter holding horizons, defined as short-term institutions, than other institutions, i.e. long-term institutions. The optimal portfolio of short-term institutions tilts towards speculative stocks that experience more volatile future demand shocks, which create transient trading opportunities. The current demand from short-term institutions increases the prices of these speculative stocks and reduces their buy-and-hold returns, making them less desirable for long-term investors. The model provides predictions relating a stock's short-term institutional ownership, trading opportunity, and expected return. In the second essay, I test the predictions of the first essay. Empirically, short-term institutions, identified as high-turnover institutions, invest more in stocks with higher CAPM beta, higher idiosyncratic volatility, and lower buy-and-hold abnormal returns. The difference in the buy-and-hold abnormal return between stocks with least and most short-term institutional investors is more than 3% per year. Stocks with more short-term institutional investors also provide more trading opportunities, allowing short-term institutions to make more trading profits. Their trading profits increase with market sentiment. This essay demonstrates that the desirability of investing in speculative stocks depends on an institution's holding horizon. The third essay examines the well-established negative relation between expense ratios and future net-of-fees performance of actively managed equity mutual funds. I show that this relation is an artifact of the failure to adjust a fund's performance for its exposures to the profitability and investment factors. High-fee funds exhibit a strong preference for stocks with low operating profitability and high investment rates, characteristics associated with low expected returns. After controlling for exposures to profitability and investment factors, I find that high-fee funds significantly outperform low-fee funds before fees and perform equally well net of fees. These results support the theoretical prediction that skilled managers extract rents by charging high fees.

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