How Retail Investors Affect the Stock Market

Abstract

Using the expansion of price limit regulation as a quasi-natural experiment, this study examines the effect of retail investors' trading activities on stock market quality. Our results show a reduction in retail investors’ trading after the expansion of the daily price limit. Furthermore, this reduction leads to a decrease in liquidity, but an improvement in price efficiency. Our study reveals an important trade-off between stock liquidity and price efficiency in financial markets dominated by retail investors. Our study complements the theoretical work of Subrahmanyam (1991) and Han et al. (2016) and highlight the complexity of retail investors' trading activities.

Keywords: Retail investors, Liquidity, Price Efficiency, Volatility, Price Limit