Informed Trading, Liquidity Provision, and Stock Selection by Mutual Funds

Front Cover
National Bureau of Economic Research, 2007 - Information theory in economics - 48 pages
0 Reviews
We show that the stock selection ability of a fund manager can be decomposed into two components: "informed trading" and "liquidity provision." As information loses value over time, informed trading tends to be liquidity-absorbing. We conjecture that value enhancing informed trading is more likely in stocks during times when they are associated with more information events. In contrast, liquidity provision is more likely to add value for stocks associated with few information events and little adverse selection risk. We identify times when there are more information events associated with a stock by its Probability of Informed Trading (PIN, Easley et. al., 1996) measure and information asymmetry component of the spread (Madhavan et. al., 1997). We provide empirical support for our conjecture using quarterly mutual fund holdings data for the period from 1983 to 2004. We find that the informed trading component is relatively more important for mutual funds with a growth oriented investment style whereas liquidity provision is more important for funds with more of an income orientation. Further, the informed trading component of the selection ability of a mutual fund exhibits greater persistence over time.

From inside the book

What people are saying - Write a review

We haven't found any reviews in the usual places.


Section 1
Section 2
Section 3

7 other sections not shown

Common terms and phrases

Bibliographic information