The Impact of Retail Investors on Stock Liquidity and Crash Risk

The influence of retail investors on the stock market is controversial among experts. Some studies conclude that retail investors are uninformed, overconfident investors who assess risk poorly and thus destabilize the financial markets (e.g., Grinblatt and Keloharju, 2009; Barber and Odean, 2013). However, more recent studies suggest that retail investors are informed investors (e.g., Boehmer et al., 2020), provide liquidity, and therefore reduce the risk of stock-price crashes and stabilize the financial market (e.g., Barrot at al., 2016). In particular, in times of financial crises, retail investors might play an important role (e.g., Mitchell and Pulvino, 2012).

In a recent paper, we shed light on the latter stabilizing argument and provide empirical evidence that retail investors decrease crash risk of stocks by providing liquidity to stock markets after a market-wide liquidity shock. To enable casual inference, we employ a difference-in-differences approach with the COVID-19 pandemic as an exogenous shock to a treatment group of stocks likely held by retail investors.

We regard the pandemic as a market-wide liquidity shock because it hit capital markets unexpectedly in March 2020 and caused steep crashes in stock markets (e.g., Albuquerque et al., 2020) as well as bond and money markets (Schrimpf et al., 2020; O’Hara and Zhou, 2021). We use data from the Robinhood trading app and define as our treatment group stocks that have average user holdings greater than the sample median in 2019. Since treatment and control firms might have different fundamentals, we examine a matched sample, using propensity score matching, where the matching is based on a set of variables prior to the outbreak of the pandemic.

We find that stocks that are likely held by retail investors have significantly higher liquidity and lower price-crash risk during the COVID-19 pandemic. We conclude that retail investors stabilize stock prices, in particular in times of financial markets turmoil. In addition, we find that retail investors’ impact on crash risk is more pronounced for stocks with low volatility, low turnover, or low short interest. Since these findings show that retail investors mitigate crash risk for stocks that are less risky or less likely overvalued, we conclude that retail investors are not just uninformed contrarian traders but rather act on some information.

We also perform several robustness tests. First, we show that institutional investors do not reduce the risk of a stock price crash, and liquidity is not significantly higher for stocks that are likely held by institutional investors. Second, we run a horse race between the effect of retail investors and institutional investors to rule out that our findings are just caused by retail investors’ mimicking institutional investors’ trading. Consistent with our hypothesis, we find that the stabilizing effect is only caused by retail investors rather than institutional investors. Third, we acknowledge that during the COVID-19 pandemic Robinhood gained tremendous popularity in 2020 so that we test whether our results still hold using a treatment group based on 2020 Robinhood data. We find the same qualitative results.

Our paper contributes to the literature in two ways. First, we contribute to information about the role of retail investors in times of financial markets turmoil. In this context, we provide causal evidence by using the exogenous shock of the COVID-19. Furthermore, we provide some support to studies such as Boehmer et al. (2020) that retail investors are not just contrarian traders with no information but might possess some superior information. As a contribution to methodology, we use direct data on retail investor holdings rather than inferring their activity indirectly from trading data (e.g., Boehmer et al., 2020). Second, our paper contributes to the stock-price crash risk literature where a number of studies examine the impact of information hiding and manipulation (e.g., Hutton et al., 2009). We extend this strand of literature by providing empirical evidence on the impact of retail investors on stock-price crash risk in times of financial markets turmoil when market-wide information and liquidity, rather than firm-specific information, determine individual stock (e.g., Kacperczyk et al., 2014).

Our study provides some managerial and political implications. First, corporate financial managers should focus on attracting retail investors in times of financial markets turmoil to maintain higher stock prices that might help in raising capital. Second, institutional managers should attract more funding from retail investors to avoid capital constraints when arbitrage opportunities are apparently most profitable. Finally, governments should motivate more retail investors to invest in financial markets with, for example, tax incentives or financial education. Doing so might reduce the need for government and central bank interventions, which can lead to higher taxes, more debt, and moral hazard.


Albuquerque, R., Koskinen, Y., Yang, S., and Zhang, C. (2020). Resiliency of environmental and social stocks: An analysis of the exogenous covid-19 market crash. The Review of Corporate Finance Studies, 9(3):593–621.

Barber, B. M. and Odean, T. (2013). The behavior of individual investors. In Handbook of the Economics of Finance, volume 2, pages 1533–1570. Elsevier.

Barrot, J.-N., Kaniel, R., and Sraer, D. (2016). Are retail traders compensated for providing liquidity? Journal of Financial Economics, 120(1):146–168.

Boehmer, E., Jones, C. M., Zhang, X., and Zhang, X. (2020). Tracking retail investor activity. Journal of Finance, Forthcoming.

Grinblatt, M. and Keloharju, M. (2009). Sensation seeking, overconfidence, and trading activity. The Journal of Finance, 64(2):549–578.

Hutton, A. P., Marcus, A. J., and Tehranian, H. (2009). Opaque financial reports, r2, and crash risk. Journal of Financial Economics, 94(1):67–86.

Kacperczyk, M., Van Nieuwerburgh, S., and Veldkamp, L. (2014).  Time-varying find manager skill.The Journal of Finance, 69(4):1455–1484.

Mitchell, M. and Pulvino, T. (2012). Arbitrage crashes and the speed of capital. Journal of Financial Economics, 104(3):469–490.

O’Hara, M. and Zhou, X. A. (2021). Anatomy of a liquidity crisis: Corporate bonds in the covid-19 crisis. Journal of Financial Economics (forthcoming).

Schrimpf, A., Shin, H. S., and Sushko, V. (2020). Leverage and margin spirals in fixed income markets during the covid-19 crisis. Available at SSRN 3761873.

This post comes to us from graduate student Felix Hüfner and Assistant Professor Jan-Oliver Strych at the Karlsruhe Institute of Technology. It is based on their recent paper, “The Impact of Retail Investors on Stock Liquidity and Crash Risk”, available here.