Dissertations, Theses, and Capstone Projects

Date of Degree

6-2024

Document Type

Dissertation

Degree Name

Ph.D.

Program

Business

Advisor

Xi Dong

Committee Members

Lin Peng

Dexin Zhou

Alexander Chinco

Subject Categories

Applied Behavior Analysis | Behavioral Economics | Finance | Finance and Financial Management | Other International and Area Studies

Keywords

Anomalies, Retail Investors, Limits to Arbitrage, Return Predictability, International Mutual Funds, Diversification

Abstract

This dissertation consists of five chapters on market efficiencies through retail and international mutual fund investors.

Chapter 1 This chapter briefly introduces this dissertation.

Chapter 2 This chapter Anomalies Never Disappeared: The Case of Stubborn Retail Investors delves into the “stubborn” retail investors and finds that anomalies traded against by retail investors never disappear in the long run, defying the conventional wisdom that anomalies are disappearing in recent years as market efficiency improves. Incorporating retail trading, I develop asset pricing models that surpass existing prominent models in explaining these long-run alphas. I hypothesize that retail investors exacerbate anomalies: the more they misact, the more they stick to their misactions, while arbitrageurs require more compensation for taking the longer-horizon risk. I obtain support by examining retail misactions, their persistence in trading, and short selling, and by examining the long-horizon risk that the short seller faces when trading against retail investors. My results suggest that retail investors and their increasing importance will contribute to the longevity of anomalies and market inefficiency by posing a horizon-based risk to arbitrageurs.

Chapter 3 This chapter Event Studies on Retail Anomaly Trading builds on the second chapter and continues to explore retail anomaly trading. Specifically, I use two exogenous shocks to retail anomaly trading to shed light on the causal inference of retail trading on anomalies. The first shock pertains to the COVID-induced stay-at-home mandates, which precipitated an unparalleled surge in retail trading. The second shock pertains to the 1st economic impact payment. Following the methodology of Divakaruni and Zimmerman (2023), I implement a regression discontinuity design to capture the effects of this sudden wealth increase on retail anomaly trading. Finally, using the Tech Bubble as an out-of-sample test, I evaluate the performance of the treatment and control group based on retail trading data from the 2010s.

I find consistent evidence from these three event studies. As retail trading increases exogenously, the retail anomaly trading towards treatment group anomalies becomes more negative and treatment group anomalies underperform control group anomalies even at the formation month. These findings suggest that retail investors indeed are likely to trade against (with) a fixed set of anomalies and are potent enough to exacerbate mispricing, posing a credible threat to arbitragers.

Chapter 4 This chapter Betting Against Others’ Beta: Revealed Preferences of Foreign Investors, shifts the focus to the international arena, examining the asset pricing implications of foreign ownership in equity markets. It highlights the diversification demands of international investors, as evidenced by their flows react positively to funds that offer exposure to the world rather than home market risks. Funds that provide diversification benefits consistently exhibit lower alpha, tilting their portfolio towards stocks with a higher world and lower home beta. Among stocks with foreign ownership in the U.S. as well as international regions, a long-short strategy on positive world beta spreads yields significantly negative alpha. These findings underscore the influence of international investors' diversification demands on asset pricing.

Chapter 5 This chapter summarizes the results and concludes.

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