(Bloomberg) -- Academics have quantified what many have long suspected, that retail investors are punching well above their weight in the stock market.
Individual investors had an impact five times the size of their estimated assets in the second quarter of 2020, according to recent research from the Swiss Finance Institute. They added 1% to the aggregate stock market valuation in that period, and 20% to the value of small cap shares, Philippe van der Beck and Coralie Jaunin wrote in a paper published in SSRN, a repository of academic research.
“Robinhood demand substantially alleviated the negative returns observed in the first quarter,” of 2020, the pair wrote. “The return effects of Robinhood demand are even more pronounced during the recovery.”
The researchers found that despite an estimated share of 0.2% of aggregate U.S. market capitalization, traders on the popular retail trading app accounted for 10% of the variation in stock returns in the second quarter of last year, when the rebound from the pandemic selloff began in earnest. That's because the smaller investors react more strongly to price changes than their institutional counterparts, they said.
A combination of free trading apps such as Robinhood and direct government stimulus helped fuel a boom in retail involvement in the U.S. stock market, most notably from first-time investors. Their influence has begun to impact markets, most notably during the recent GameStop Corp. share frenzy, and trading volumes have skyrocketed.
While the impact of Robinhood traders is concentrated toward small cap stocks and the consumer staples industry, they are also able to affect the price of some large companies, which are being held primarily by passive investors, according to the study.
Future Volatility
The outsized activity of retail investors provided “considerable” liquidity to the U.S. stock market during the crash, but growth in the cohort could lead to a higher level of equity volatility in the future.
“The prominent role of Robinhood traders in driving returns evokes concerns about the future role of retail trading in equity markets,” they said. “If -- facilitated by novel fintech solutions -- the retail sector continues to grow its wealth share, the extraordinary volatility observed during the pandemic may turn out to be the new normal.”
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