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ABSTRACT
This paper explores the relationship between retail investor participation rates (RP) and United States equity valuations as well as equity market risk premiums from 2010-2023. Retail participation grew from 10.1% to 18% over this timeframe while valuations grew over 25% and equity risk premiums declined by 15%. Our analysis focuses on relationships between retail participation rates (RP) and market valuation metrics, including S&P 500 price-to-earnings (P/E), price-to-book (P/B), and price-to-sales (P/S) ratios while controlling for market risk measures like bond yields (10 YR), risk free rates (FFR), equity risk premiums (ERP), and volatility (VIX). Findings reveal retail participation exhibits a strong direct relationship with higher market valuations both uncontrolled and after controlling for the effect of market wide and macroeconomic covariates. This suggests retail investors have been a significant driver of rising P/E, P/B, and P/S ratios over the study period. Additional analysis points to retail trading contributing slightly to lower equity risk premiums without materially impacting volatility over the study period.
Key words: retail participation, valuation, risk premium, equity markets
INTRODUCTION
Over the past decade, the number of retail traders participating in the United States (US) equity markets has increased substantially. The leading cause of this increase was the rise of inexpensive and easy-to-use brokers like Robinhood, which first entered the market in 2013 (Curry, 2024). These brokers provide market access to individuals lacking significant financial acumen (Abramson, 2017) and to those who previously could not afford to participate in the market. The jump in retail participation can be seen as the percentage of retail participation in the markets increased from just 10.10% in the first quarter of 2010 to 18% in the second quarter of 2023.
This paper explores the relationship between retail investor participation rates (RP) and the stock market. This paper examines the parallel behavior between the RP increase and the valuations of public companies and the cost of equity. Quarterly data was taken from the first quarter of 2010 to the second quarter of 2023. The data points that were collected were RP, volatility index (VIX), the federal funds rate (FFR), equity risk premiums (ERP), US 10-year yield (US10Y), cost of equity (COE), price-to-earnings ratio for S&P 500 companies (S&P P/E), the Shiller price-to-earnings ratio (Shiller P/E), the...