This article is based the research of Kelley Professor of Finance and Richard E. Jacobs Chair in Finance, Vivian Fang. This work was co-authored by Zhi Da (University of Notre Dame) and Wenwei Lin (Chinese University of Hong Kong).
Introduction
Retail trading has sharply increased in U.S. equity markets in recent years—thanks, in large part, to advances in mobile-friendly trading technology like Robinhood, which has eased access to stock markets for Millennial and Gen Z investors. Post-pandemic policy responses have also played a role; stay-at-home restrictions and distribution of unemployment and stimulus dollars have left people with more time and spare cash to spend on trading.
Despite this, most retail investors still have limited capital. Many stocks, which can trade at a single share well above a quarter million dollars, have long been considered out of reach for most retail investors.
In recent years, in an attempt to attract new retail clients, brokers like Robinhood have allowed stock purchases by the slice for as little as a penny. In turn, retail investors with low capital have been able to trade prominent stocks that tend to have a steep price tag.
This rise in fractional trading—the ability to trade less than a whole share—on high-priced stocks has sharply increased since 2019. And these “tiny trades,” increasingly coordinated during attention-grabbing events on social media, are actually forceful enough to exert price pressure on high-price stocks, creating trading frenzies and bubbles.
How do these tiny trades make such a big impact? When fractional traders pour into a popular so-called “meme stock,” its price increases. A memorable example is January 2021’s dramatic spike in trading on GameStop stock, which was organized on Reddit. In these instances, capital providers may interpret the price increase as a positive signal of firm fundamentals and become more willing to offer capital. The enhanced access to financing improves firm valuation, prompting more speculation, which creates a reinforcing loop of frenetic buying and price rising.
To better understand how fractional trading might affect retail activity and return patterns of high-priced stocks, researchers from Indiana University, the University of Notre Dame and the Chinese University of Hong Kong partnered to study the introduction of fractional trading and its impact on asset prices.
Statement of Problem
Retail investors are commonly believed to favor lower-priced stocks because they believe that such stocks are more likely to appreciate and are predisposed to think more in terms of share than dollar. Given these biases, the authors wanted to study the extent to which fractional trading leads retail investors to enter and trade high-priced stocks.
And if the introduction of fractional trading has facilitated an increase of tiny trades of high-priced stocks, are the effects too small to exert economic impact? Or could fractional trading, fueled by social media, give rise to trading frenzies and bubbles of meme stocks like GameStop?
Data Sources Used
For their analysis, the authors relied on off-exchange one-share trades to capture fractional-trading-facilitated trading by capital-constrained marginal investors.
Analytic Techniques
To establish the causal effect of fractional trading on tiny trades in high-priced stocks, the authors compared high-priced stocks to low-priced stocks based on industry and pre-fractional-trading characteristics like book-to-market, stock popularity, institutional ownership, and growth in daily one-day shares—controlling for things like earnings announcements and past stock returns.
Next, to assess the impact of coordinated tiny trades on asset prices, the authors identified a daily list of 25 stocks with the most positive price movements, 25 stocks with the most negative price movements, and 25 stocks with the largest increase in Google abnormal search volume index relative to the stock’s average in the past 90 days. Then, the authors combined the lists to create a super set of stocks experiencing retail attention spikes.
Last, to study the extent to which fractional trading contributes to meme-stock-like trading frenzies and fuels bubbles, the researchers used a regression analysis to evaluate the likelihood of experiencing a bubble for higher- versus lower-priced stocks.
Results
The authors established that the introduction of fractional trading has facilitated a significant increase of tiny trades in high-priced stocks.
Specifically, compared to low-priced stocks—those with a share price less than $100 at the end of November 2019—high-priced stocks have experienced a larger increase (14.1%) in the daily number of off-exchange one-share trades after fractional trading first became available in November 2019. High-priced stocks experienced a further increase of 138.7% after fractional trading became more widely available in U.S. markets in January 2020 through Fidelity.
Consistent with fractional trading investors driving the surge of tiny trades, the result was concentrated in a subsample of stocks with lower institutional ownership, robust to using a lower price cutoff ($75, 77th percentile) or a higher price cutoff of ($150, 92nd percentile).
Turning to the impact of coordinated tiny trades, the authors found that after the introduction of fractional trading, high-priced stocks in the super set list experienced a larger increase in off-exchange one-share trades, social media discussions, and price pressure than their low-priced
counterparts. This result suggests that attention-coordinated tiny trades are forceful enough to exert price pressure on high-priced stocks.
Using GameStop as a leading example of a meme stock, the authors found that a fractional trading-facilitated bubble is more likely to occur in a high-priced stock if the stock is prominently discussed on the Reddit forum r/wallstreetbets. They also show that the increase in tiny trades as a percentage of total trades is positively related to contemporaneous price change, confirming that the price patterns observed for GameStop extend to a larger sample of stocks.
A fractional trading-facilitated bubble is also more likely to occur in a high-priced stock if a firm faces more binding financial constraints, consistent with the firm’s valuation benefiting more from improved access to financing. Additionally, a fractional trading-facilitated bubble is more likely to occur in firms whose capital providers are more sensitive to recent price movements, precisely when the feedback effect is predicted to play a bigger role.
Lastly, the authors show that tiny trades by fractional trading investors, when coordinated by attention, can cause significant price fluctuations in high-priced stocks.
Business Implications
Financial economists have long noted that the stock market is not just a sideshow; stock prices in the secondary financial markets serve an important informational role. Stock price provides aggregate information about firm value—and real decision makers can learn from this information to guide their decisions.
The authors’ findings provide support for predictions that fractional trading investors, predominantly capital-constrained Millennials and Gen Z, are susceptible to social media influence. The fact that their collective trading through fractional trading can give rise to meme-stock-like trading frenzies and fuel bubbles is worthy of attention.
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