On Short-term Institutional Trading Skill, Behavioral Biases, and Liquidity Need

Are portfolio managers skilled or do they trade too much? Using a marked-to-market based“fair-value” method for measuring fund manager skill, we find that institutional managers canpotentially earn +42 (+33) basis points benchmark-adjusted return before transaction costs aftera holding period of four weeks on their buy (sell) trades. After transaction costs, the benchmark-adjusted return for the buy (sell) trades is +1 (-8) basis points. Pension fund managersoutperform money managers. We are unable to detect evidence for overconfidence among pensionfund managers over this short-horizon. In addition, we are unable to find evidence of dispositioneffect among mutual fund managers. Institutions tend to engage in short-term tradeswith holding period of four weeks (or less) despite only breaking-even or making economicallyinsignificant (modest) benchmark-adjusted losses after round-trip transaction costs for liquidity,risk-management, or tax-minimization reasons. Among these, evidence for liquidity trading motiveis the strongest