Retail investors’ preferences for lottery stocks : Are retail investors overinvesting in lottery-type stocks due to wealth constraints?

Abstract

We find that retail investors on aggregate are less attracted to stocks with highly skewed returns after an exogenous increase in stock tradability. Using data on the number of Robinhood investors owning U.S. stocks, we estimate the effect of the newly introduced Fractional Share Trading service to causally reduce retail investor holdings of such stocks by 30.78%. This finding is significant at the 10% level and is estimated using a Regression Discontinuity Design. Through a Difference-in-Difference analysis, we estimate a causal increase in the number of retail investors holding stocks that can be traded fractionally. However, when running a subgroup analysis of stocks with above median return skewness, retail investors’ demand for such stocks is about 50% lower than for their low-skewed counterparts. Nevertheless, as both results from the DiD analysis are insignificant, they provide no conclusive answer. Lastly, using standard OLS, we observe that the significant positive relationship between skewness of stock returns and retail investment disappears once we control for stock tradability. Although these results are subject to uncertainty, all our findings suggest that wealth constraints can help explain why we observe an overrepresentation of retail investors in lottery-type stocks.