Working Paper: CEPR ID: DP10820
Authors: Jeannol Barrot; Ron Kaniel; David Sraer
Abstract: This paper examines the extent to which individual investors provide liquidity to the stock market and whether they are compensated for doing so. We show that the ability of aggregate retail order imbalances, contrarian in nature, to predict short-term future returns is significantly enhanced during times of market stress, when market liquidity provisions decline. While a weekly rebalanced portfolio long in stocks purchased and short in stocks sold by retail investors delivers 19% annualized excess returns over a four-factor model from 2002 to 2010, it delivers up to 40% annualized returns in periods of high uncertainty. Despite this high aggregate performance, individual investors do not reap the rewards from liquidity provision because they experience a negative return on the day of their trade and they reverse their trades long after the excess returns from liquidity provision are dissipated. During the financial crisis, French active retail stock traders stepped up to the plate, increased stock holdings, and provided liquidity. In contrast, mutual fund investors fled from delegation by selling their mutual funds.
Keywords: Crisis; Liquidity; Retail Investors
JEL Codes: G01; G11; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Experience in trading (F19) | Better returns (G19) |
| Retail trading (L81) | Negative returns on the day of trading (G12) |
| Retail order imbalances (C69) | Future stock returns (G17) |
| Retail order imbalances (C69) | Annualized returns (G12) |
| Retail trading behaviors (L81) | Excess returns (G19) |