Naïve Style-Level Feedback Trading in Passive Funds

Markus S. Broman

Journal of Financial and Quantitative Analysis, 2022, vol. 57, issue 3, 1083-1114

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.

Date: 2022
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