Which Factors Are Priced? It Depends on Who You Ask : Investor Heterogeneity and Factor Pricing

Institutional ownership plays important and strikingly opposite roles in factor pricing for macro-related and characteristic factors. Early studies have found that the beta-sorted portfolios of both types of factors have a tiny and insignificant return spread. However, the macro-related (characteristic) factors have a significantly larger (smaller) risk premium within stocks held by institutions compared to stocks held by retail investors. For long-short portfolios based on macro-related composite beta, those formed with stocks with high institutional ownership have a return spread that is 66 basis points higher per month relative to those owned mainly by retail investors. In contrast, composite characteristic beta-sorted long-short portfolios formed with stocks owned mainly by retail investors earn a return spread that is 81 basis points higher per month relative to those owned mainly by institutions. This empirical evidence indicates that the “flat” risk premium of pervasive factors can be partly attributed to the tug-of-war between institutions and retail investors, with the former behaving more consistently with the fundamental risk-averse investors described in classic models and the latter behaving in the opposite way. It is also consistent with the conjecture that macro-related factors are more likely to be a proxy for risk, whereas characteristic factors are more likely to be a proxy for mispricing