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Factor demand and factor returns

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  • UserDr Cameron Peng Assistant Professor of Finance, LSE World_link
  • ClockThursday 11 March 2021, 13:00-14:00
  • HouseOnline.

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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.

This talk is part of the Cambridge Finance Workshop Series series.

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