How mutual funds respond to asymmetric feedback trading in China's stock market

Previous studies show that individual investors play a dominant role in China's stock market. Their behavior of chasing-rise being stronger than killing-fall leads to asymmetry of feedback trading. Our article investigates how mutual funds react to this market force. Using China's stock and fund data from 2003 to 2019, we find that mutual funds tend to hold fewer shares when asymmetric feedback trading of the relevant stock gets more intense. This negative relationship is robust after controlling past returns, turnover rates, and firm risk factors, moreover, it attenuates when the market sentiment is bullish or when stocks are allowed short-selling. Further results show that mutual funds' selling towards asymmetric feedback trading does not make excess return but leads to significant risk reduction. Our findings may be related to uncertainty associated with asymmetric feedback trading, and thus support the limit market participation theory from the second largest stock market.