We study brokerage platform outages to examine the impact of retail investors on financial markets. We contrast outages at Robinhood, which caters to inexperienced investors, with outages at traditional retail brokers. For stocks with high retail interest, we find that negative shocks to Robinhood investor participation are associated with reduced market order imbalances, increased market liquidity, and lower return volatility, whereas the opposite relations hold following outages at traditional retail brokerages. The findings suggest that herding by inexperienced investors can create inventory risks that harm liquidity in stocks with high retail interest, while other retail trading improves market quality.

Conference: China International Conference in Finance, Securities and Exchange Commission, NYU Stern/Salomon Center Microstructure Conference, Financial Management Association, Northern Finance Association, Paris December Finance Meeting, Midwest Finance Association

Closing auction volume steadily increased over the last decade, and it reached a peak of about 10% of the total trading volume in 2019. We examine the price impact and resiliency of closing auctions, and we compare closing auction liquidity in Nasdaq and the NYSE. The NYSE offers more depth. In both exchanges, it takes about 3–5 days for the temporary component of the price impact to fully dissipate. Trading strategies that exploit this price impact and its reversals are significantly profitable.

Conference: World Symposium on Investment Research

Unique features and market frictions can lead to idiosyncratic pricing for some US Treasury securities. This study uses a linear programming (LP) model to measure aggregate idiosyncratic pricing of T-notes and T-bonds from 1980 to 2016. We document an average idiosyncratic pricing of $0.11 per $100 par, as compared to an average bid-ask spread of $0.08. Further, idiosyncratic pricing declined dramatically from the early 1980s to the 2010s. Empirical evidence suggests that the 1986 Tax Reform Act, increasing issue sizes and improving market liquidity contribute to the decline. At the individual security level, we identify factors contributing to and mitigating idiosyncratic pricing.

Retail trading in complex (multi-leg) options has grown significantly following the introduction of zero commissions by several brokerage firms. We show that the returns on these complex orders are negative on average (-16.4% over three-day holding periods), and that the higher the complexity, the lower the returns. We also find that a significant fraction (28%) of complex options trades are around firms’ earnings announcements, and these trades lead to significant losses. Subjective volatility expectations from complex volatility options suggest that retail investors overestimate expected volatility during earnings announcements. Overall, our findings suggest that retail investors are playing a losing game by betting on complex options strategies because of their lottery-like payoffs.

This paper studies model-free trade-revealed subjective expectations of returns using complex options trades from 2010 to 2021. Contrary to the extrapolative survey-based expectation of returns, trade-based expectations of returns positively predict future returns and are negatively correlated with past returns, highlighting the difference between survey-based expectations and trade-based expectations. Trade-revealed expectations are heterogeneous and time-varying, and such heterogeneity in beliefs predicts positively future returns. The subjective tail risk from put spread has predictive power for the aggregate market. Overall, the evidence suggests trade-revealed expectations are consistent with the rational expectation model and offers a novel high-frequency measure of subjective expectations from trade.

The closing auction has experienced significant growth over the last decade, and it has become increasingly important to traders. We find that the price impact in closing auctions in the US is significantly smaller than that in continuous markets. The opening auctions are relatively less active and less liquid. The price impact is significantly correlated with stock characteristics such as exchange, price, and volatility in all three trading avenues. We also examine the trading costs of several common trading strategies and find that the trading costs in closing auctions are smaller than that in the continuous market for all strategies.

Retail investors dominate option trading in recent years. Individuals are net purchasers of options, particularly call, short-dated, and out-of-the-money options, although they tend to write long-dated puts. Retail brokerage outages are associated with reduced implied volatility overall, and the effect is stronger for options purchased by retail investors. In contrast, implied volatility increases for long-dated options during outages, consistent with reduced retail writing activity. The findings highlight the importance of retail demand pressure on the implied volatility surface and suggest that retail trading can have important effects on the implied volatility term structure, moneyness curve, and call-put spread.

Conference: FMA Conference on Derivatives and Volatility, SFS Cavalcade Asia-Pacific 2022

We examine the price discovery process of initial public offerings (IPO) from the offer price to first day’s open price. Stock exchanges have made major changes to the IPO preopening process, and introduced an open auction process in which all investors are able to enter orders and participate in price discovery. The time spent in preopening has increased for IPOs over the years with an average of 77.23 minutes in 2020. The same pattern is not found for SPACs. The percentage of the day’s volume executed in the IPO Cross is much higher at 15.3% than the approximately 1% for non-IPO stocks. Each phase of preopening contributes to incremental price discovery with almost all of the price adjustment occurrs during preopening. However, for “cold” IPOs half of the price adjustment takes place after the market opens. Even though participation by retail investors has increased during preopening, their role in price discovery is limited. Our results suggest that institutional investors use the IPO Cross to sell shares. We also find that underwriters take advantage of changes implemented after the Facebook IPO that gave them a bigger role in deciding when to release an IPO for trading.

Financial Intermediation Research Society

We find that the illiquidity premium is mainly attributable to recent loser stocks, consistent with the possibility that it is driven, in part, by return reversals in these stocks. Among the illiquid, loser stocks, stocks that were recently sold by mutual funds subsequently show significantly greater returns than the stocks that were recently purchased, suggesting that the effect relates to a price rebound following negative price pressure. We further find that when accounting for the fact that stock liquidity is highly correlated with market capitalization, there is little evidence to suggest that an illiquidity premium extends beyond the small cap anomaly.