Retail traders and co-movement: Evidence from Robinhood trading activity

Abstract

We find evidence that retail trading activity by Robinhood traders is associated with lower levels of return co-movement and liquidity co-movement. We demonstrate the significance of these relationships primarily employing a two-way fixed effects panel data regression model covering cross-sectional and time-series observations of US stock trades from May 2018 to July 2020. The findings hold true across various cross-sectional subsamples and across subperiods before and after March 2020, coinciding with the stock market crash induced by heightened risks of the COVID-19 pandemic. With regard to returns, our analysis identifies three co-movement channels: 1) increased correlated trading by retail traders, 2) extended delay in incorporating market-wide information, and 3) a direct effect influenced by the integration of firm-specific information into prices. In contrast, for liquidity co-movement, we fail to identify evidence of plausible channels relating to either volatility or correlated trading. However, it appears that the significant direct effects that we document stem from a broadened array of trading strategies when retail traders contribute to the market. Collectively, these findings have important implications as return co-movement limits investors' ability to diversify investments and manage risks, while liquidity co-movement heightens market vulnerability to crashes.