Irrationality of the New Crowd: Behavioral Biases of Post-COVID Robinhood Investors

Abstract

The COVID-19 pandemic generated a unique set of circumstances – increased free time due to stay-at-home lockdowns and government stimulus checks – that led to a rapid rise in retail trading. This thesis investigates whether two behavioral biases: a) chasing returns and b) limited attention were exhibited to a greater level in the new wave of Robinhood users that joined post-March 11th, 2020. To test the chasing returns bias, I estimated a fixed effects model of daily lagged returns controlling for company and date fixed effects. The results indicate that the new post-COVID investors were 2.7x times and 3.5x times more likely to purchase (sell) a stock that experienced positive (negative) daily and one-day lagged returns respectively compared to the pre-COVID investors. Specifically, during the Re-Opening phase, this susceptibility to purchase (sell) a stock that had positive (negative) daily returns was 4.9x times the pre-COVID investors. To test the limited attention bias, I estimate a fixed effects model applied to an event-study of +/– 10 days to earnings announcements. These results find that the new wave of post-COVID Robinhood investors underreacted more on the date of the announcement but overreacted more on the day after, especially when the Standardized Unexpected Earnings (SUE) score was in the Top 10% or Bottom 10% of scores. These discoveries provide empirical support to accentuate that retail traders can, and will, perpetuate certain market inefficiencies and their growth as a group in equity markets will persist in posing crucial challenges to the Efficient Market Hypothesis.