Dynamic Competition of Retail and Institutional Investors: Pricing and Volatility

Asset pricing theory offers a number of theoretical models focusing on competition between retail investors on financial markets. However, due to the rapid development of financial markets the institutional trading activity becomes more and more prominent today. In this paper, I examine the fundamental factors influencing the variance of price of a risky asset when both institutional and retail investors are engaged in trading activity. As a result, I have concluded that that the variation of a price is negatively correlated with the risk aversion of small and institutional investors, but positively with the number of large investors engaged in trading activity, as well as with their relative bias parameter and the difference between the expected payoffs of the final dividends. I argue that on the markets, where institutional investors scantly take into account the success of its peers, the variance of stocks would be lower than on those markets, which are populated entirely with small investors.