Author: Du, Qingjie
Title: Two essays on asset pricing and retail investors
Advisors: Wei, K. C. John (AF)
Degree: Ph.D.
Year: 2022
Subject: Assets (Accounting)
Retail trade
Stocks -- Prices
Individual investors
Hong Kong Polytechnic University -- Dissertations
Department: School of Accounting and Finance
Pages: viii, 126 pages : illustrations
Language: English
Abstract: This thesis contains two essays. The commonality of the two essays is that I investigate the role and impact of the retail trading activities on the asset pricing in both essays. In the first essay, I focus on the option market, and investigate the impact of retail investors trading activities of the underlying stocks on the corresponding cross-sectional option returns. In the second essay, I decompose the aggregate retail order imbalance into pure buying order and pure selling order, and examine the pricing impact on the cross-sectional stock returns separately.
Specifically, in the first essay, I examine the relation between the cross-sectional delta-hedged option returns and the retail investor trading activities of the underlying stocks. I hypothesize that the option price could be affected either by the retail investor's gambling appetite or affected by the noise trader risk associated with retail trading activities. Empirically, I find that both call option returns and put option returns decrease as the retail trading volume of the underlying stocks increases. Further analysis shows that the retail trading order imbalance (i.e. the betting direction) does not predict future option returns, but that the volatility of retail trading activities does. The pricing effect of retail trading volume becomes stronger when retail trading is more volatile or when the stock's arbitrage cost is high. A test using Abel Noser data suggests that institutional trading activities do not affect the delta-hedged option returns. Overall, the results suggest that the trading activities of retail investors increase options' hedging costs and hedging difficulty, and option writers charge higher prices to compensate for this noise trader risk.
In the second essay, I decompose the retail order imbalance into aggregate selling orders and aggregate buying orders, and document an asymmetric pricing effect between the selling orders and buying orders. Specifically, the long-short hedge portfolio formed based on retail selling orders generates about 10 bps abnormal return each day, i.e., 2% each month. However, the aggregate retail buying orders cannot predict the cross-sectional stock returns. The previous documented positive relationship between cross-sectional stock return and retail order imbalance could be mainly driven by the selling side. Stocks with intensive aggregate retail selling orders continue to underperform in the future, receive excess retail selling pressure, and are associated with drying-up liquidity. The pricing effect of retail selling orders becomes stronger when the VIX is high or when market is bearish, and when the stock is hard to value, but disappears on Fridays when the investor mood is high.
To summarize, the two essays provide new evidence on the role and impact of the retail investors in the financial market. The results help both the market participants and the policy makers to better understand the impact of retail investors on the asset pricing.
Rights: All rights reserved
Access: open access

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