Institutional Investors and the Time-Variation in Expected Stock Returns
Authors: Rüdiger Weber (University of Michigan)
Title: Institutional Investors and the Time-Variation in Expected Stock Returns
Abstract: I show that the higher the share of institutional ownership in a stock, the more its price-dividend ratio is driven by discount rate variation rather than by changes in dividend growth expectations. Hence, the dividend yield of stocks with high institutional ownership predicts returns. Conversely, for stocks held mostly by individual investors, returns are not predictable. As a general equilibrium outcome, return predictability crucially depends on the properties of the marginal investor. More strongly time-varying marginal utility of institutions acting as marginal investors in the respective stocks provides a natural explanation for the observed pattern. In an equilibrium model, time-varying redemption risks generate the observed predictability patterns among a priori identical stocks. My findings helps explain the weak return predictability of small and value stocks, the postwar predictability reversal, and the fact that dividend smoothing cannot explain that reversal.