Are Retail Traders Compensated for Providing Liquidity?

57 Pages Posted: 8 Dec 2014

See all articles by Jean-Noel Barrot

Jean-Noel Barrot

HEC Paris

Ron Kaniel

University of Rochester - Simon Business School; CEPR

David Alexandre Sraer

University of California, Berkeley; Princeton University

Multiple version iconThere are 3 versions of this paper

Date Written: December 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.

Keywords: financial crisis, individual investor, liquidity, retail investor

JEL Classification: G10, G11, G12, G14

Suggested Citation

Barrot, Jean-Noel and Kaniel, Ron and Sraer, David Alexandre, Are Retail Traders Compensated for Providing Liquidity? (December 2014). CEPR Discussion Paper No. DP10285. Available at SSRN: https://ssrn.com/abstract=2535422

Jean-Noel Barrot (Contact Author)

HEC Paris ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

Ron Kaniel

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

HOME PAGE: http://rkaniel.simon.rochester.edu

CEPR ( email )

London
United Kingdom

David Alexandre Sraer

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544-0708
United States

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