Investors’ Horizons and the Amplification of Market Shocks (Presentation)

After severe negative market shocks, institutional investors with short trading horizons are inclined or forced to sell their holdings to a larger extent than investors with longer trading horizons. This may amplify the effects of market-wide shocks on the prices of stocks held by short horizon investors. We test the relevance of this mechanism by exploiting the negative shock caused by Lehman Brothers’ bankruptcy in September 2008. Consistent with our conjecture, short-term investors sell significantly more than long-term investors around and after the Lehman Brothers’ bankruptcy. Most importantly, stocks held by short-term investors experience more severe price drops and larger price reversals than those held by long-term investors. Our results cannot be explained by characteristics of the institutions’ investment styles other than their investment horizons. We also show that the effect of investor trading horizon emerges during other episodes of severe market turmoil, such as the October 1987 market crash. Overall, the empirical evidence strongly indicates that investors’ short horizons amplify the effects of market-wide negative shocks.

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