Market Efficiency and the Problem of Retail Flight

In 1950, 91 % of common stock in the U.S. was owned directly by individual inves­ tors. Today, that percentage stands at only 23%. The mass exodus of retail investors and their investment dollars has negative implications not only for capital formation and investor protection, but also for market efficiency. Individual investors are often assumed to be noise traders who distort stock prices and harm market functioning. Therefore, some argue that their withdrawal from the market should be of little concern; indeed, it should be celebrated. Recent empirical evidence calls this assertion of retail noise trading into doubt, and this pa­ per, which describes a study that employs New York S tock Exchange retail trading data, con­ tributes to the debate. This study (1) reveals that as the proportion of trading by individual investors increases, stock price informativeness, as measured byfirm-specific return variation (R2) and the probability of informed trade (PIN), increases and (2) provides evidence that suggests these relationships are causal ones. This study, therefore, provides evidence that, contrary to the received wisdom, retail trading may increase share price accuracy and market efficiency. Thus, there may be substantial reasons to lament retail investor flight