Content area
Full Text
We investigate the differences in the holdings of institutional investors relative to individual investors during an eight-month period between March and November 2000, where the Nasdaq Composite index fell 46.23% in value. We find evidence that during that market decline, institutional investors held stocks with less return volatility than individual investors. Our evidence of institutional investor preference for holding lower volatility stocks in a declining market may indicate their relatively greater sensitivity to downside risk. As a consequence, institutional investors are found to perform better than individual investors during that specific time period. [G12, G23]
There is mixed empirical evidence on the hypothesis that institutional investors are attracted to less risky stocks. Badrinath, Gay, and Kale (1989) and Aggarwal and Rao (1990) find evidence that links the level of institutional holdings with lower risk stocks. On the other hand, Kothare and Laux (1995) find evidence to suggest that institutional investors are associated with more volatile stocks.
Using a comprehensive data set covering the period 1980-1996, Gompers and Metrick (2001) find that institutional investors compared to individual investors prefer stocks in larger market capitalization companies that are more liquid and have higher book-to-market ratios. They do not, however, detect any significant relation between institutional holdings and stock return volatility. In a study that documents the preferences of US open-end mutual funds, Falkenstein (1996) considers only the years 1991 and 1992, and finds that mutual funds display a preference for high-volatility stocks.
Sias (1996) argues that institutional investors are likely to choose less volatile stocks for several reasons: 1) many institutions are governed by the prudent man rule; 2) greater institutional interest may imply more and better information; and 3) institutional investor behavior is less susceptible to fads or noise trading influences. Contrary to this intuition, Sias (1996) finds that higher levels of institutional ownership for NYSE listed securities, over the period 1977-1991 are associated with higher contemporaneous stock return volatility. He concludes that the evidence is against an interpretation that institutional investors tend to select riskier stocks, but that an increase in institutional ownership may itself be the cause of increased volatility.
While the results of Gompers and Metrick (2001) and Sias (1996) are inconclusive with respect to whether institutional investors prefer less risky...