Retail broker trading restrictions and market liquidity: an examination of GameStop

ABSTRACT

We examine changes in market liquidity when several popular U.S. retail brokers restrict client trading in GameStop stock over a six-day period in early 2021 due to higher clearinghouse deposit requirements. When retail investor participation in a high-attentionstock becomes restricted, trading activity declines and trading venue shifts occur – there is less trading in dark markets and more fragmented trading across U.S. stock exchanges. We also find that when a stock order flow mix becomes comprised of fewer retail investors and a higher concentration of institutional investors, the quoted bid-ask spread widens, and trading cost measures rise significantly.

KEYWORDS:

• Trading
• liquidity
• U.S. equities
• GameStop

jel code:

• G10
• G14

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ See http://financialservices.house.gov/calendar/eventsingle.aspx?EventID=407107 and http://www.banking.senate.gov/hearings/who-wins-on-wall-street-gamestop-robinhood-and-the-state-of-retail-investing.

² In the U.S. equity market, approximately 40% of trading occurs away from the stock exchanges in dark markets.

³ For example, in the first quarter of 2021, payment for order accounted for more than 80% of Robinhood’s revenue. http://www.wsj.com/articles/robinhoods-debut-is-clouded-by-sec-scrutiny-of-payment-for-order-flow-11625655600.

⁴ As noted by Barber, Lin, and Odean (2022), this result is not inconsistent with prior studies that show retail order imbalance positively predicts short term returns (e.g. Barber, Odean, and Zhu 2008; Kaniel, Saar, and Titman 2008; Kaniel et al. 2012; Kelley and Tetlock 2013).

⁵ Boehmer et al. (2021) and Barber et al. (2022) develop algorithms for identifying retail trades on publicly available data (New York Stock Exchange (NYSE) Daily Trades and Quotes (TAQ) database).

⁶ Although trading restrictions imposed on GameStop were the most notable and the focus of the congressional hearings, some researchers have examined the events of early 2021 more broadly across different restrictions, stocks, times, and markets. For example, Jones, Reed, and Waller (2021) examine various margin and trading restrictions imposed on 38 stocks, from January 22, 2021 through March 12, 2021, in equity and option markets. They document a large shift in trading volume from restricted equities to options.

⁷ The Securties and Exchange Commission (2021) noted in their report that, ‘Some in the media directly linked trading activity to the presence of short interest, characterizing trading in GameStop as an act of rebellion intended to humble short-selling professional investors who had allegedly targeted the stock’..

⁸ http://www.wsj.com/articles/robinhoods-gamestop-debacle-spurs-calls-to-modernize-stock-clearing-11612780200.

⁹ http://robinhood.engineering/when-and-why-we-restrict-trading-a4df54e0c839.

¹⁰ http://www.nyse.com/market-data/historical/daily-taq.

¹¹ An institutional customer account is defined by FINRA Rule 4512(c) as a bank, investment adviser, or any other person with total assets of at least $50 million. An individual customer account is an account that does not meet the definition of an ‘institution’ and is also not a proprietary account.

¹² The trading restrictions were posted on Robinhood’s website and also noted in popular press outlets (e.g. The Wall Street Journal, CNBC, etc.).

¹³ We also compute results using a five-minute interval for robustness. The results are qualitatively similar to those reported and omitted for brevity. They are available upon request.

¹⁴ See Holden and Jacobsen (2014), including their Internet Appendix.

¹⁵ We also conduct analyses using two other trade classification algorithms in the financial literature (e.g. Ellis, Michaely, and O’Hara 2000; Chakrabarty et al. 2006). The results are qualitatively similar to those reported and omitted for brevity. They are available upon request.

¹⁶ For this analysis, the liquidity measures are computed at the daily level (rather than at the one-minute interval) for computational feasibility.