The role of institutional investors and individual investors in financial markets: Evidence from closed‐end funds

I use closed‐end funds as a unique research tool to explore whether institutional investors are a stabilizing or a destabilizing force in financial markets. If institutional investors stabilize the market by trading against mispricing, then they should purchase closed‐end funds selling at a wide discount and sell funds selling at a large premium. Consistent with the market‐stabilizer hypothesis, I document that wide‐discount funds experience a higher subsequent institutional demand than premium funds do. Moreover, my findings that an increase in institutional ownership forecasts a decrease in the volatility of discount returns support the proposition that institutional trading reduces noise trader risk. In sum, the results suggest that institutional investors play a price‐stabilizing role in financial markets.