Individual Investors and Volatility

Thierry Foucault, David Sraer and David Thesmar

No 6915, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Idiosyncratic volatility; Noise trading; Retail investors (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ifn, nep-mst and nep-upt
Date: Written 2008-07

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