Trading behavior-stock market volatility nexus among institutional and individual investors

Abstract In contrast to previous studies that investigated the impact of the investment groups’ trading volume on the volatility of the stock index, this research, inspired by behavioral finance literature, aims to evaluate the dynamic bi-directional relationship between the trading behavior of investor groups (institutional and noninstitutional) and stock index fluctuations in different positions (long and short) and market conditions (the pre-COVID-19 and COVID-19 periods) in the Turkish stock market. The results indicate a bidirectional relationship between the stock index return (SIR) and the trading behavior of online individual traders (OIT) and equity mutual and pension funds (EMPF). However, this relationship varies depending on the trading positions of different investor groups. Also, there is a unidirectional relationship between the SIR and the trading behavior of the diversified equity funds (DEF). During the pandemic period, the role of online traders became more prominent, coinciding with their increased participation in the market, significantly affecting and being affected by stock index fluctuations. We also evaluated some behavioral biases (including overconfidence and asymmetric reaction) and the trading strategy of investor groups (with their performance). Results suggest that the online individual traders were less (more) overconfident than other groups in the prepandemic (pandemic) period. Additionally, all groups had an asymmetric reaction to the positive and negative SIR shocks. This research, contributing to the field of financial innovation and aligning with behavioral finance principles, reveals a fascinating finding: individual investors react to stock index fluctuations, largely driven by institutional investors, despite lacking access to new fundamental information about their portfolio stocks. These findings have significant implications for investors and market regulators. Recognizing and addressing behavioral biases is crucial for individual investors as they strive to make informed and successful financial decisions. It is concluded that the surge in retail investment is a phenomenon; hence, more effort is required for their investment stability in the Turkish stock market.