How do retail investors react to a market crash? The role of investment literacy

ABSTRACT

This study investigates retail investors’ behaviour when the US stock market dropped precipitously by 10% in early February 2018. Results show that investors with higher investment literacy were more likely to buy additional stocks and less likely to sell their stocks, which indicates that they expected a quick recovery of the market. We also find that older investors and investors with greater risk aversion were more likely to hold their positions without buying or selling stocks. Similar evidence is found in reactions to a 20% hypothetical market drop. This study sheds light on the meagre literature on retail investors’ behaviour during market crash.

KEYWORDS:

• Investor behaviour
• market crash
• investment literacy

JEL CLASSIFICATION:

• D14
• D12
• G53

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ A report published by Fidelity analyzes how often market crashes have occurred in the US stock market. See https://www.fidelity.com/learning-center/trading-investing/markets-sectors/stock-market-corrections.

² See the reference page published by CNN: https://money.cnn.com/2018/02/28/investing/stock-market-february-dow-jones/index.html.

³ To address potential endogeneity of investment literacy, we have conducted additional analyses suggested by Schwarz (2018). Overall, findings from the analyses alleviate endogeneity concerns and show consistency with the main findings. Full results are available from the authors upon request.