Published online by Cambridge University Press: 03 June 2022
Fund flows are more correlated among funds with similar investment horizon, consistent with correlated demand for liquidity. We find that stocks held by institutions with more heterogeneous investment horizon are more liquid and have lower volatility of liquidity. Identification tests confirm that the improvement in stock liquidity holds when the increase in investor heterogeneity arises from an exogenous shock due to the 2003 tax reform. In addition, extreme flow-induced trading by institutional funds has a bigger price impact when stocks have a less heterogeneous investor base. Moreover, the premium associated with stock illiquidity is concentrated in stocks with low investor heterogeneity.
We thank an anonymous referee, Ruchith Dissanayake, Wayne Ferson, Jarrad Harford (the editor), Fuwei Jiang, He Wang, David Whidbee, conference and seminar participants at the Chinese University of Hong Kong, 2017 Asian Finance Association Annual Meeting, 2017 China International Conference in Finance, and SFS Cavalcade Asia-Pacific 2017 for helpful comments. Chan acknowledges financial support from the Hong Kong Research Grants Council (Project #: GRF 690013). Hameed acknowledges financial support from NUS Academic Research Grant R--315-000-124-115.