Retail and Institutional Trades and the Cross-Section of Corporate Bond Returns

Prof. Jason Wei

University of Toronto

About the Speaker

Jason Wei is a Professor of Finance in the Department of Management at the University of Toronto-Scarborough, with a cross-appointment to the Finance area at Rotman. His early research was mainly on derivatives valuation and applications. His recent research is on empirical asset pricing, focusing on options liquidity and trading. He is currently on the editorial board of The Journal of Derivatives. He was the Finance Division Editor of the Canadian Journal of Administrative Sciences from 2005 to 2011. In addition to his teaching and research duties, Jason is also active in various industry consulting activities and professional education programs.

Abstract

This paper investigates the cross-section association between retail and institutional trades and corporate bond returns. Based on the TRACE Enhanced data from 2002 to 2012, I find that bonds heavily bought by retail investors in one month underperform in the next month relative to bonds heavily sold by retail investors, and the opposite holds for institutional investors. The alpha of the high-low portfolio (formed based on decile sorting on the buy-sell trade imbalance) relative to the usual market factors is significant for retail investors, but insignificant for institutional investors. The overall results confirm the notion that retail investors suffer from certain behavioral biases, consistent with the findings for the stock market. However, when the spread between the purchase and sell prices is factored into the returns (something that has not been done in the stock market studies), no profitable trading strategy exists. The study also finds that risky bonds attract institutional investors while less risky bonds attract retail investors.