How do Individual, Institutional, and Foreign Investors Win and Lose in Equity Trades Evidence from

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How do Individual, Institutional, and Foreign
Investors Win and Lose in Equity Trades?
Evidence from Japan

• Kee-Hong Bae
• Korea University and Queens University
• Takeshi Yamada?
• National University of Singapore
• Keiichi Ito
• Nomura Securities International, New York

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Efficient markets

• No investors consistently perform better (or
  worse) than others
• On the other hand.
• Many studies have found different investor types
  have distinct patterns of trade
• Research question
• How are these patterns related to performance?

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Previous studies Individuals (Institutions)
have poor (good) performances

• Barber-Odean (2000), Odean (1999) AER,
  Lee-Liu-Odean (2004)
• Generally poor performance after trading cost
• High turnover
• Grinblatt-Keloharju (2000) JFE
• Do not pick future winning stocks very well
• Cohen (1999)
• Individuals buy from institutions after price
  increases bad timers
• Cohen-Gompers-Vuolteenhao (2002) JFE
• Institutions profit from individuals from
  underreaction of prices to good cash flow news

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Previous studiesDomestic vs. foreign investors

• Foreigners predicts future returns better than
  domestic investors
• Seasholes (2000), Froot-OConnell-Seasholes
  (2001) JFE, Froot-Ramadorai (2001), Karolyi
  (2002) PBFJ, Kamesaka-Nofsinger-Kawakita (2003)
  PBFJ
• Domestic investors predicts future returns better
• Dahlquist-Robertsson (2004) JBF
• Foreigners do not have private information
  advantage
• Choe-Kho-Stultz (2005) RFS
• Dvorak (2005) JF
• Foreigners buy more after large price hikes
• Choe-Kho-Stultz (2005) RFS

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Our paper

• Examine all investor types across the market
• Examine different aspects of trade performance
• market timing
• price spreads
• trading interval
• Examine how gains and losses shift among
  different investor types

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DataTokyo Stock Exchange (1st Section) weekly
trading data

• Jan 1991-April 1999 (until trade were allowed off
  the exchange)
• Buy and sell trade volume and value
• Trade by different investor types
• Individual investors, nonfinancial corporations,
  mutual funds, insurance companies, banks,
  proprietary trades of securities firms

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Table 1.Sell price/Buy price Spread

• Trade-weighted sell and buy price spreads
• Individual 11.75
• Nonfonancial corp 5.22
• Mutual funds 0.50
• Insurance co -12.92
• Banks 32.16
• Foreigners -1.49
• Proprietary traders -0.16

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Table 2 Simple correlations

• Correlations of net buys
• Domestic investors vs. foreign investors
• Nonprofessional investors vs. institutional
  investors (money managers)
• Correlations with market returns
• The net buy of foreign investors have strong
  positive correlation with past and future
  returns.
• Domestic investors have negative correlations

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Table 3 Seasonal patters of trade

• Fiscal-year-end selling of domestic institutions
• Fiscal-year-end buying of foreign investors (and
  individual investors)

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Performance of Equity Trading

• Trading gains Net cash flows generated by
  trades
• Net increase in portfolio holdings due to trade
  not due to capital gains/losses as in
  conventional performance measures
• Standardization
• Number of shares Buy and sell the same number of
  shares
• Value of trades net buy is zero yen over the
  observation period
• Can compare across different investor types
• Testable statistic

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Overall net trading gains
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Net gains from intertemporal price spreads
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Net gains from market timing
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Test

• Null hypotheses
• ?0, ps0, pT0
• Signed-rank test
• Overlapping data (dependency) and seasonal
  patterns (periodicity)
• Cannot use conventional standard error as it
  assumes independent data
• Generate block bootstrap sample for testing

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Table 4 Panel AAll months

• The figures are in Yen that are generated from
  buy and sell trades with a median value of 100
  yen each.
• Individual investors
• gain for short-term intervals from positive price
  spreads (due to selling the winners and holding
  onto the losers?)
• but loses in long-term from poor market timing
• Foreigners (and banks)
• positive timing performance

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Table 4 Panel BFiscal-year-end

• Foreign investors gain more over the Jan-Mar
  period (especially from market timing)
• Banks, non-financial corporations, insurance
  companies lose more during Jan-Mar
• Foreigners take advantage of the selling of
  domestic institutions.
• Selling might be due to year-end adjustment of
  portfolio and/or accounting reasons.

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Table 5 Correlations of trading gains among the
investor types

• Net gains from price spreads
• Shifts between nonprofessional investors
  (individual and nonfinancial corporations) and
  institutional investors (smart money managers)
• Net gains from timing performance
• Shifts between foreign and domestic investors
• This effect dominates the overall result

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Conclusion

• Different investor types have different sources
  of equity trading gains and losses
• Individual investors are poor in predicting
  future market returns but might gain in
  short-term trading by churning stocks
• Foreign investors might not have better private
  information and are momentum traders
  (Brennan-Cao, 1997). Despite this fact, they are
  good in predicting future returns.

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Conclusion

• Different institutional background of the
  investors provides opportunity for trade.
• Foreigners buy up from domestic institution at
  fiscal-year-end