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Individual Investors and Volatility

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Author Info
Foucault, Thierry
Sraer, David
Thesmar, David

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Abstract

We test the hypothesis that individual investors contribute to the idiosyncratic volatility of stock returns because they act as noise traders. To this end, we consider a reform that makes short selling or buying on margin more expensive for retail investors relative to institutions, for a subset of French stocks. If retail investors are noise traders, theory implies that the volatility of stocks affected by the reform should decrease relative to other stocks. This prediction is borne out by the data. Moreover, around the reform, we observe a significant decrease in (i) the magnitude of returns reversals, and (ii) the Amihud ratio for the stocks affected by the reform relative to other stocks. We show that these findings are also consistent with models in which individual investors, acting as noise traders, are a source of volatility.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6915.

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Date of creation: Jul 2008
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Handle: RePEc:cpr:ceprdp:6915

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Related research
Keywords: Idiosyncratic volatility; Noise trading; Retail investors;

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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