Presenter: Francesco Franzoni, USI Lugano

Title: Avoiding Idiosyncratic Volatility: Flow Sensitivity to Individual Stock Returns

Abstract: While sizeable returns are generated around earnings announcements and the risk-return tradeoff improves at these times, we find that institutional investors on average reduce their exposure to announcing stocks. A novel and surprising empirical result on the flow-performance sensitivity to individual stock returns allows us to explain this behavior. In particular, we find that extreme realizations of announcement returns for an individual portfolio holding lead to substantial outflows. Reducing the exposure to the announcing stocks before the earnings release mitigates these outflows. We build a model that accounts for this specific tradeoff that institutions face and we rule out systematic risk and transaction costs as potential explanations. Overall, the paper identifies a new friction limiting institutional arbitrage capability.

Host: Thomas Kokholm