When expectations of implicit government guarantees diminished, do retail stock investors run away?

We investigate the impact of implicit government guarantees (IGGs) on the trading behavior of retail stock investors for non-default firms, using China’s first corporate bond default in March 2014 as a negative shock to public expectations of IGGs. Our difference-in-differences analysis shows that, following the Chaori default shock, retail investors withdraw from high-default-risk firms that have not yet defaulted. This outcome is not attributed to industry, geographical or supply-chain contagions, declining stock prices, worsened financial metrics, or merely a seasonal effect. The effect is more pronounced for firms with preexisting larger retail ownership breadth or higher stock trading turnovers, for non-state-owned enterprises, and for firms with less sustainable earnings. When the initial default shows signs of a bailout, retail investors’ withdrawal partially reverses. Overall, the diminishment of IGGs seems to have reduced the moral hazard of retail stock investors and encouraged them to focus more on firms’ fundamentals, potentially enhancing the capital allocation efficiency in China’s stock market in the long run.