Finance Seminar: Victor DeMiguel

Crowding and Trading Diversification in Factor Investing

Victor DeMiguel, London Business School

Abstract: The growing number of institutions exploiting smart-beta strategies raises concerns that crowding may increase price-impact costs and thus erode their pro ts. We identify a mechanism, trading diversification, that alleviates these concerns: Other institutions exploit strategies that can reduce the price-impact costs of smart beta even when their trades are not negatively correlated with smart-beta trades. We study how trading diversification affects the equilibrium. We find that while decentralization (different institutions exploiting different strategies) reduces investment positions and profits compared to centralization, competition among institutions exploiting the same strategy can restore investment positions and profits to those under centralization.
(joint work with Alberto Martin-Utrera, Raman Uppal)