Institutional Ownership and Aggregate Volatility Risk

The paper shows that the difference in aggregate volatility risk can explain why several anomalies are stronger among the stocks with low institutional ownership (IO). Because of their desire to hedge against aggregate volatility or to exploit their competitive advantage in obtaining and processing information, coupled with the dislike of uncertainty and volatility, institutions tend to stay away from the stocks with extremely low and extremely high levels of firm-specific uncertainty and growth options. Consequentially, the spread in the measures of uncertainty and growth options is wider for low IO stocks, and the same is true about the differential in aggregate volatility risk. I demonstrate empirically that the ICAPM with the aggregate volatility risk factor can completely explain why the negative relation between market-to-book, idiosyncratic volatility, turnover, and analyst disagreement, on the one hand, and future returns on the other is stronger for the stocks with low IO. The same mechanism explains why the positive relation between IO and future returns is stronger for growth firms and high uncertainty firms. JEL Classification: G12, G14, G23, E44, D80