Discussion Paper Details

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Title: What Alleviates Crowding in Factor Investing?

Author(s): Victor DeMiguel, Alberto Martin-Utrera and Raman Uppal

Publication Date: September 2021

Keyword(s): capacity of quantitative strategies, Competition and price impact

Programme Area(s): Financial Economics

Abstract: The growing number of institutions exploiting factor-investing strategies raises concerns that crowding may increase price-impact costs and erode profits. We identify a mechanism that alleviates crowding -- trading diversification: institutions exploiting different characteristics can reduce each other's price-impact costs even when their rebalancing trades are not negatively correlated. Empirically, trading diversification increases capacity by 45%, optimal investment by 43%, and profits by 22%. Using a game-theoretic model, we show that, while competition to exploit a characteristic erodes its profits because of crowding, competition among institutions exploiting other characteristics alleviates crowding. Using mutual-fund holdings, we provide empirical support for the model's predictions.

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Bibliographic Reference

DeMiguel, V, Martin-Utrera, A and Uppal, R. 2021. 'What Alleviates Crowding in Factor Investing?'. London, Centre for Economic Policy Research.