Small Trades and the Cross-Section of Stock Returns

Abstract

This paper uses volume arising from small trades to analyze the effect of retail investor trading behavior on the cross-section of stock returns. The central finding is that stocks with intense sell-initiated small-trade volume, measured over the past several months, outperform stocks with intense buy-initiated small-trade volume. This return difference accrues from the first month after the portfolio formation up to two years later. Among small and medium-sized firms, the return difference continues in the third year. The results suggest that stocks favored by retail investors become overvalued and subsequently experience prolonged underperformance relative to stocks out of favor with retail investors.

JEL Classification: G12, G14