Are Retail Traders Compensated for Providing Liquidity?
48 Pages Posted: 23 Jun 2014 Last revised: 14 Oct 2015
There are 3 versions of this paper
Are Retail Traders Compensated for Providing Liquidity?
Are Retail Traders Compensated for Providing Liquidity?
Are Retail Traders Compensated for Providing Liquidity?
Date Written: June 20, 2014
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 (i) they experience a negative return on the day of their trade, and (ii) 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: retail investor behavior, return predictability, liquidity provision
JEL Classification: G14
Suggested Citation: Suggested Citation
Register to save articles to
your library
Recommended Papers
-
Does Academic Research Destroy Stock Return Predictability?
By R. David Mclean and Jeffrey Pontiff
-
A Five-Factor Asset Pricing Model
By Eugene F. Fama and Kenneth R. French
-
Dissecting Anomalies with a Five-Factor Model
By Eugene F. Fama and Kenneth R. French
-
…and the Cross-Section of Expected Returns
By Campbell R. Harvey, Yan Liu, ...
-
Short-Term Reversals: The Effects of Institutional Exits and Past Returns
By Si Cheng, Allaudeen Hameed, ...
-
Passive Investors, Not Passive Owners
By Ian Appel, Todd A. Gormley, ...
-
Time-Varying Liquidity and Momentum Profits
By Doron Avramov, Si Cheng, ...
-
A Demand System Approach to Asset Pricing
By Ralph S. J. Koijen and Motohiro Yogo
-
Can Brokers Have It All? On the Relation between Make-Take Fees and Limit Order Execution Quality
By Robert H. Battalio, Shane A. Corwin, ...
-
By Itzhak Ben-david, Francesco A. Franzoni, ...