Essays on Institutional Investors and Asset Pricing

Yelekenova, Adina and Wang, George and Yao, Chelsea (2025) Essays on Institutional Investors and Asset Pricing. PhD thesis, Lancaster University.

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Abstract

This thesis contains two essays on the strategic trading behavior of hedge funds in two key contexts: ETF rebalancing and environmental incidents, revealing significant market impacts and the distinct roles of institutional investors. The first essay, “ETF rebalancing, hedge fund trades, and capital markets” the interaction between ETF rebalancing and hedge funds (HFs) trades. Our analysis reveals that the transparency and predictability inherent in ETF rebalancing provide opportunities for anticipatory trading by HFs, who gradually adjust their long and short positions ahead of ETF rebalancing. While ETF rebalancing is associated with strong price distortions of the underlying securities, we demonstrate that HFs’ anticipatory trading exaggerates the price impact of non-fundamental demand, highlighting the hidden costs of ETF rebalancing. The second essay, “Post-environmental incident drift and institutional trades: who benefits from environmental shocks?”, examinesthe impact of environmental incidents on stock returns and the trading patterns of various institutional investors, with a focus on hedge funds. We document a significant negative drift in stock returns following environmental incidents, persisting over one quarter. Our analysis reveals that banks, pension funds, and insurance companies exert significant selling pressure on high ESG risk stocks post-incident. In contrast, hedge funds often purchase these depressed stocks, capitalizing on the temporary price drops induced by the divestments of environmentally conscious investors. Notably, non-PRI signatory hedge funds generate positive returns from this strategy, while PRI signatories do not demonstrate similar trading behaviors. This investigation highlights the divergent strategies of institutional investors, with hedge funds playing a crucial role in providing liquidity and exploiting opportunities from climate-related risks. Overall, this thesis contributes to the understanding of ETF rebalancing dynamics and the market impacts of ESG incidents. It emphasizes the strategic roles of hedge funds in navigating these financial landscapes, offering insights into how their anticipatory and opportunistic trading behaviors can influence market efficiency and stability.