Institutional Investors, Households, and the Time-Variation in Expected Stock Returns

I document a new stylized fact: the higher the degree of institutional ownership (IO) in a portfolio, the more time-varying expected returns rather than changes in expected dividend growth drive changes in its valuation. Empirical evidence suggests that institutions’ time-varying sensitivity to the risk of holding stocks translates into time-varying expected returns on high-IO stocks. In my model, imperfect risk sharing between different types of investors generates cross-sectional differences in return predictability based on ownership, even among a-priori identical stocks. My findings help explain the weak return predictability of small and value stocks and predictability reversals of stocks and REITs.