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Naïve Style-Level Feedback Trading in Passive Funds

Published online by Cambridge University Press:  08 April 2021

Markus S. Broman Open the ORCID record for Markus S. Broman [Opens in a new window]
Markus S. Broman*
Affiliation:
Syracuse University Whitman School of Management
*
[email protected]
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Abstract

Passive exchange-traded funds (ETFs) are ideally suited to style-level feedback trading because of their high liquidity, ease of short selling, and pure play on investment styles. I find strong evidence of short-term style-momentum trading in ETFs. Institutional investors that use ETFs do not act as arbitrageurs by trading against style momentum. Institutions, especially less sophisticated ones, are themselves style-momentum traders. Moreover, recent style-level demand predicts style-level return reversals. These findings suggest that uninformed positive feedback trading by less sophisticated market participants can destabilize financial markets in the short run.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 3 , May 2022 , pp. 1083 - 1114
Copyright
© The Author(s), 2021. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

I am grateful to Anna Agapova, Kee-Hong Bae, Jennifer Conrad (the editor), Shaun Davies (the referee), Jon Fulkerson, Viktoriya Lantushenko, Marc Lipson, Alexey Malakhov, David Pedersen, Sara Shirley, Pauline Shum, Viktoriya Staneva, Yisong Tian, Tim Trombley, Abhishek Varma, David Weinbaum, Gulnara Zaynutdinova, Gaiyan Zhang, Yijia Zhao, and Blerina Bela Zykaj and seminar participants at the University of Arkansas, the University of Missouri–St. Louis, the University of New Hampshire, the University of Massachusetts–Boston, Illinois State University, Rutgers University–Camden, Syracuse University, West Virginia University, the 2018 European Finance Association Conference, the 2018 Eastern Finance Association Conference, and the 2017 Financial Management Association Conference for many helpful comments and suggestions. A previous version of this article was distributed with the title “Positive Style-Level Feedback Trading and Noise Trader Demand.” All errors are my own.

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