Factor demand and factor returns

Cameron Peng and Chen Wang

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: A mutual fund's demand for a pricing factor, measured by the loading of the fund's returns on the factor's returns, is persistent over time. When stock characteristics are time-varying and change frequently, persistence in factor demand generates a need for rebalancing. This rebalancing motive, in turn, leads to predictable trading from mutual funds and contributes to cross-sectional return predictability. In particular, when there is a "mismatch" between a stock's characteristic and the underlying funds' demand for that characteristic, the "mismatched" stock will face selling pressure from the underlying funds and subsequently earn lower returns. Double-sorting on stocks' characteristics and mutual funds' factor demand refines value and momentum strategies, generating abnormal returns that cannot be explained by subsequent fundamentals or retail trading flows.

JEL-codes: G12 G23 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2021-03-11
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