Date of Degree


Document Type


Degree Name





Lin Peng

Committee Members

Xi Dong

Dexin Zhou

Joseph Weintrop

Subject Categories

Finance and Financial Management


institutional trading, liquidity, investor attention, market efficiency, herding


This dissertation consists of three chapters that examine the role of institutional investors in stock market efficiency. Institutions are important and influential market participants. This study aims to analyze whether institutional investor trading is consistent with higher attention and better skill, what is the impact of institutional trading on future asset prices and how does institutional trading relate to the liquidity in the market.

The first chapter of the dissertation analyzes institutional investors’ response to stock level liquidity shocks. I find that institutions, especially the transient ones, buy stocks that experience positive liquidity shocks and sell those that experience negative ones. High-low decile portfolios representing difference between stocks with positive and negative liquidity shocks are related to future increase in institutional trading 53% higher than the amount of average monthly institutional trading. Changes in ownership induced by the high-low liquidity shocks positively predict 5.03% annualized return in the subsequent month. This trading activity further amplifies the liquidity shocks through feedback effects. The results suggest that institutional investors help improve market efficiency by exploiting the mispricing associated with liquidity shocks, although their trading exacerbates stock level liquidity uncertainty.

The second chapter examines trading behavior of institutional investors in attention grabbing stocks. I find that institutions increase their trading volume on high attention days, both buys and sells. Both liquidity demanding and supplying institutions are abnormally active on those days, despite significantly higher transaction costs. I document outstanding demand for liquidity by institutional investors on high attention days. Those findings suggest that institutional trades are consistent with limited attention theory. Institutions’ trading decisions result in poor performance, especially following demand buys, and even more so on high attention days. Professional money managers who supply liquidity enjoy positive long-term performance, particularly those trading on high attention days, and they benefit from higher transaction costs. Overall the study contributes to the discussion on the role of institutional investors in the stock market, pointing to their low sophistication and poor trading decisions, which may lead to exacerbation of the mispricing in the market. On the other hand, some of them serve a positive and stabilizing role as liquidity suppliers.

The third chapter studies aggregate herding behavior of institutional investors over 35 years. I find significant evidence of aggregate herding over that time period, based on Sias (2004) dynamic herding measure. Interestingly, I observe large shocks to herding activity during the dot com bubble in 2000-2001, in times of high uncertainty regarding the valuations of new companies. There is a positive relation between herding and aggregate market uncertainty as measured by the average stock correlation. The analysis of relation between herding and future returns does not however point to the distorting impact of herding on information incorporation into stock prices. I document a positive relationship between herding activity and next quarter aggregate market return. There is no reversal in the following 3 quarters, contributing to the view that herding may in fact enhance overall pricing efficiency in the market.