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Are Retail Traders Compensated for Providing Liquidity?

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  • Sraer, David
  • Kaniel, Ron
  • Barrot, Jean-Noël

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.

Suggested Citation

  • Sraer, David & Kaniel, Ron & Barrot, Jean-Noël, 2014. "Are Retail Traders Compensated for Providing Liquidity?," CEPR Discussion Papers 10285, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:10285
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    More about this item

    Keywords

    Financial crisis; Individual investor; Liquidity; Retail investor;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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