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Follow the leader: fund managers trading in signal-strength sequence

When fund managers trade sequentially in the same direction, the information confirmation hypothesis predicts the long‐term profitability of the leader trade to be increasing in the number of subsequent trades. The information cascade hypothesis predicts a non‐positive relationship. Using active equ...

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Bibliographic Details
Published in:Accounting and finance (Parkville) 2011-09, Vol.51 (3), p.684-710
Main Authors: Fong, Kingsley Y. L., Gallagher, David R., Gardner, Peter A., Swan, Peter L.
Format: Article
Language:English
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Summary:When fund managers trade sequentially in the same direction, the information confirmation hypothesis predicts the long‐term profitability of the leader trade to be increasing in the number of subsequent trades. The information cascade hypothesis predicts a non‐positive relationship. Using active equity funds’ daily trading data, we document a transition from information confirmation to information cascades as the number of followers increase. We find that highly disguised multiple‐broker packages exhibit higher market impact, higher long‐term returns and are associated with fewer followers. Our study also documents that lead fund managers face portfolio risk constraints in trading on private information.
ISSN:0810-5391
1467-629X
DOI:10.1111/j.1467-629X.2010.00367.x