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Title: Are Retail Traders Compensated for Providing Liquidity?

Author(s): Jean-Noël Barrot, Ron Kaniel and David Sraer

Publication Date: December 2014

Keyword(s): financial crisis, individual investor, liquidity and retail investor

Programme Area(s): Financial Economics

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.

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Bibliographic Reference

Barrot, J, Kaniel, R and Sraer, D. 2014. 'Are Retail Traders Compensated for Providing Liquidity?'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10285