Working Paper: CEPR ID: DP6915
Authors: Thierry Foucault; David Sraer; David Thesmar
Abstract: We test the hypothesis that individual investors contribute to the idiosyncratic volatility of stock returns because they act as noise traders. To this end, we consider a reform that makes short selling or buying on margin more expensive for retail investors relative to institutions, for a subset of French stocks. If retail investors are noise traders, theory implies that the volatility of stocks affected by the reform should decrease relative to other stocks. This prediction is borne out by the data. Moreover, around the reform, we observe a significant decrease in (i) the magnitude of returns reversals, and (ii) the Amihud ratio for the stocks affected by the reform relative to other stocks. We show that these findings are also consistent with models in which individual investors, acting as noise traders, are a source of volatility.
Keywords: idiosyncratic volatility; noise trading; retail investors
JEL Codes: G11; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Suppression of the French forward equity market (G15) | Decrease in volatility of stocks previously traded on that market (G10) |
| Suppression of the French forward equity market (G15) | Decrease in absolute value of autocovariance of stock returns for treated stocks (C22) |
| Suppression of the French forward equity market (G15) | Decline in Amihud ratio for treated stocks post-reform (G18) |