What Effect is Brokerage Robinhood Having on Stock Market?

By Michelle Villagomez, UC Davis Media Relations Intern

Zero-fee brokerage Robinhood is named after the legendary outlaw who stole from the rich to give to the poor. However, a new study indicates the exact opposite is happening, with sophisticated traders exploiting Robinhood’s “naive” investors, as reported recently in the Irish Times.

“Attention Induced Trading and Returns: Evidence from Robinhood Users,” co-authored by behavioral finance expert Brad Barber, of University of California, Davis, Graduate School of Management, notes half of Robinhood users are first-time investors. And they tend to be drawn to “attention-grabbing” stocks in the news. 

Brad Barber
Brad Barber, UC Davis

As a result, herding takes place, they say in their working paper, with Robinhood investors flocking into the same stocks at the same time. This gets noticed by short-sellers, who then bet against these same stocks.

Betting against Robinhood users is a profitable business; the top stocks bought by Robinhood users fall by five percent over the next month while the most extreme herding events see reversals of nine percent.

Free trading, it seems, can be a costly business, says an Irish Times columnist who wrote about the paper. 

More about the paper

The study “Attention Induced Trading and Returns: Evidence from Robinhood Users,” is available at the Social Science Research Network. The authors are Barber, Xing Huang, and assistant professor of finance at the Olin Business School of Washington University in St. Louis, Terrance Odean, professor of finance at UC Berkeley’s Haas School of Business, and Christopher Schwarz, associate professor of finance at UC Irvine’s Merage School of Business. 

In this paper, researchers found that Robinhood users are more subject to attention biases and more likely to chase stocks with extreme performance and volume than other retail investors. “We systematically identify the Robinhood herding episodes and document that these episodes are followed by abnormal negative returns,” the authors wrote in the paper. “We show that Robinhood herding is influenced by information that is prominently displayed on the

Robinhood app. And we show that Robinhood herding can be forecasted by attention measures, such as lagged absolute returns and lagged abnormal volume, previously shown to affect the buy-sell imbalances of retail investors.”

“As we show, simply focusing the attention of many investors on a small number of stocks can promote herding behavior that affects market returns and redounds to the investors’ detriment,” the authors conclude in their paper. “Thus, while it is important that investors have access to transparent, pertinent information, disclosure alone is not sufficient to assure good investor outcomes; how information is displayed influences decisions in ways that can both help and hurt investors.”

Part of this story is excerpted from an Irish Times story by Proinsias O'Mahony



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