Meme stocks and systematic risk

“Meme stocks” are dangerous business. They are vulnerable to wild and unpredictable price swings based on rumors and discussions on web forums. They are traded primarily by retail investors in search of the following big thing with little regard for valuation models or the underlying fundamentals of the corporate.

While the movements of meme stocks look like random and present unsystematic risks, the query is how meme stocks move relative to stock market indices and other meme stocks.

Once a stock becomes a meme, we found that it not only exhibits higher overall risk or volatility, but in addition a stronger correlation with U.S. equity indices and other meme stocks. In fact, once a stock reaches meme status, its correlation with other meme stocks increases to over 80%, in line with our estimates.

So what’s a meme stock? In our evaluation, we define them based on their prominence on Reddit’s WallStreetBets discussion forum. Once a stock has crossed a certain threshold of attention on the forum, we categorized it as a meme and recorded the date it reached that benchmark. AMC Theaters, GameStop, Tesla, Bed Bath & Beyond, and Tilray, to call just a few, have all garnered the requisite attention on WallStreetBets, in addition to amongst retail traders and within the media, to be considered a meme and have been added to our list.

Using this dataset, we first examined how a stock’s correlation with various indexes modified once it became a meme. We found that meme stocks’ correlation with the Russell 2000 increased probably the most once they entered meme territory: Their correlation coefficient rose from 0.29 to 0.39. Their correlation with the S&P 500 rose from 0.26 to 0.27.

We defined big mover days as days when a meme stock’s price moved by no less than 10%. When a meme stock rose 10% or more, the S&P 500 rose by a mean of 0.26%. On days when a meme stock fell 10% or more, the S&P 500 rose by a mean of 0.13%. This again highlights a positive correlation between meme stocks and the market.

Correlations

So how has the correlation of meme stocks modified over time?

The average correlation between pre-meme stocks was 0.21. However, once they became meme stocks, their correlation with one another increased to 0.38. That’s a rise in co-movement with other meme stocks by greater than 80%.

For comparison, GameStop and AMC had a correlation coefficient of 0.08 before they became memes. Once they crossed the meme threshold, their correlation with one another jumped to 0.45.

Volatility on an unadjusted basis also increased significantly once a stock reached meme status. Before meme status, stocks had a mean volatility of 83%. This increased to 106% once they became memes. For example, AMC’s volatility on an annualized basis increased from 134% before meme status to 239% after meme status.

Meme Stock Correlation

Overall, stocks have traded way more closely with the small-cap Russell 2000 index and with other meme stocks after they became memes. This increased correlation suggests a risk that investors should concentrate on.

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Photo credit: ©Getty Images / Bruce Bennett / Staff