Small Trade, Retail Investors and Asset Dynamics

In this paper, we construct a model incorporating the retail trader’s reluctance to sell into losses. We show that in this setup the informed trader always buys the asset when he receives a favorable signal. However, when the informed trader receives an unfavorable signal, he may not sell the asset if the signal is moderately bad and the retail trader is reluctant to realize losses. Hence the asset price exhibits steady climbs with sharp and sudden drops. We then test the empirical implications using a set of high-tech stocks, many of which are dominated by retail investors. We show that the prices of these companies exhibit pattern of steady rises with sudden drops. The more trading activities by the retail investors, the more pronounced this pattern. ∗Fuqua School of Business, Duke University, Durham, NC 27708. email: [email protected]. I would like to thank Professors Pete Kyle and John Graham for their guidance and many insightful comments. All errors are mine.