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Factor demand and factor returns

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  • Peng, Cameron
  • Wang, Chen

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.

Suggested Citation

  • Peng, Cameron & Wang, Chen, 2021. "Factor demand and factor returns," LSE Research Online Documents on Economics 118884, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:118884
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    File URL: http://eprints.lse.ac.uk/118884/
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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