In a long time, the efficient market hypothesis (the EMH) is regarded as a core content of the rational market. The theory of the EMH is the basic framework while analyzing the operation mechanism of stock market. However, over the past few years, with in-depth empirical research and the application of sociology, psychology and other related knowledge, the issue that whether the price of stock can make rational response to the information or may affected by the strong psychological speculation has drawn a lot of debate. In a large number of economists, the supports of the EMH theory begun to recognize that the stock price was dominated by non-rational elements in real world (Fama, 1991).
The phenomenon of speculation is rather normal in real stock market. But so far, there is no unified explanation of the microscopic part of psychology to analyze the speculation behavior of stock market. Shefrin (2002) stated that the financial activity for finance is the behavior of the participants of financial market. So that, the dissertation will take the view from behavioral finance, take the unique perspective of market participants (mainly individual investors) and analyze the speculation in Chinese stock market.
As the speculation behavior of stock market is based on the human nature and psychological factors, it is a common phenomenon in stock market. It is important to analyze it in China, a developing country with low level of per-capita income. Compared with developed countries, most of the 'wealthy' investors in China are actually in 'middle class' which want to achieve rich without endeavor. Moreover, it would be interesting to research for the ordinary residents which have limited channel of investment and it is common sense that they may show impulse facing a new thing such as the stock market.
The theory of behavioral finance developed in the 1980s, and many research of finance focused on the employment of aspects of psychological, which 'in order to picture the evolution of stock prices on the grounds of various aspects of investor's behavior.'(Hachicha, 2010). Herd behavior is an important research interest of behavioral finance. In a certain period, the herd behavioral happens when the same strategy (to buy or sell) is adopted and the behavioral agent of specific assets in transactions reach or over a certain number of accounts. It is not easy to confirm if herd behavior exists in stock market and the question attracts many researches. Is there any herd effect in individual investors in Chinese stock market? Are they overconfidence or have forecasting errors? That will be the other questions the dissertation concerns.
Shleifer (2000) pointed out that the efficient market hypothesis is based on three hypotheses. First of all, the investors are rational and they can assess the security price rationally. Secondly, even if the investors are not rational, due to the randomness of transaction, it can offset the impact on prices. Thirdly, the arbitrage mechanism of market can return the price into rational. Kahneman and Tversky (1973) proposed the concept of 'frame' and believed that the way of 'frame' affects decision-making. Moreover, Kahneman and Riepe (1998) proposed concept of 'reference point' which insisted that the investors were affected by different reference points when making decisions. The above two concepts both challenge the first assumption of Shleifer. Based on the socialization of non-rational investors by Shiller (1984), it refuted the randomness of the second assumption. Mullainathan and Thaler (2000) revealed 'learning effect', which criticize the randomness of the transactions further.
At this time, the theory of behavioral finance sprouts. The premise of the behavioral finance is that the conventional financial theory overlooks the realities of how people make decision and the different decision-making between people (Barberis and Thaler, 2002). During the process of emotional, through the investors' own respective preferences, personality, beliefs and emotions results system and non-system emotion deviations. The first part should be mentioned is overconfidence. During the questionnaire survey that Shiller did after crash in the U.S. stock market in 1987, Shiller asked them if they know the rebound happened that day, 28% of non-involved investors make an affirmative answer and half of the involved people said 'yes'. When asked if so, how you knew as a further question, most people answered like 'intuition', 'historical evidence' and 'common sense'. Such hindsight let the investors do not attach the importance to the reflection on the behavior. This also can be regarded as people always believe their own judgment.
Loss aversion is something that when facing the same losses and gains, the mood of investors gets a greater impact on losses. 'Endowment effect' has associated on it which reflects that take the current status as a reference point, accept the loss is harder than bear the income, so that the decision-makers prefer the current status. Meanwhile, Benartzi and Thaler (1995) suggested 'myopic loss aversion' which believed that long-term gains may interrupted by short-term losses which lead to the 'casino theory'. Otherwise, 'regret aversion' means that people feel the pain when they make wrong decisions. Erlich, et al (1957) examined the consumer's response after buying cars. They choose to avoid reading car advertisements of the other cars but only concerned on their own choice car's advertisement.
Keynes's view (1930) of speculation is widely accepted which indicates that the speculators are characterized by their willingness on tolerating risks but not defined by their knowledge or specific beliefs. Moreover, after comparing, their trading partners show more risk-averse 'hedgers'. By contrast, Holbrook took the point of view that no matter 'speculative' or 'hedging' are both depending on the difference in knowledge and beliefs as to price aspects (Hirshleifer, 1975).
Based on the traditional theories and methods of investment and policy-making, assume that the investors are risk averse, they make decisions under the condition of future earning and the perspective of the entire portfolio investments. The investors always make consistent, accurate and unbiased rational expectations. Their behavior is rational and will not be influenced by subjective psychological and behavior factors. However, due to the influence of psychological factors and obviously have some non-rational behavior characteristics in investment, the traditional methods cannot easily explain it. The herd behavior is a manifestation of the non-rational behavior in stock market, Herding refers to that when the participants of stock market make an irreversible decision, they ignore their own information and affected by the other investors, and they mimic the investment behavior of the others as well. Herd behavior is often regarded as the inefficient production asset price, and one of the main reasons that the price bubble burst. The operation has great influence on the market efficiency and stability.
A basic model of herd behavior has been developed by Banerjee (1992), Bikhchandani, Hirshleifer and Welch (1992) which indicated that the herd behavior may come from private information but not public ones. In a working paper by Bikhchandani and Sharma (2000) mentioned that even the assumption for the foreign direct investment in countries with fixed exchange rates is reasonable, the theory is not quite a compliant model of stock market that the decisions of investment may reflect in the later price of the investment.
Avery and Zemsky (1998) set a model and applied it to the stock market which revealed that the price of stock market is informational efficient and no herd behavior appear. Another theory was set by Scharfstein and Stein (1990), whose theory has two main points, not all investors are full rational (mainly focus on the noise traders) and the risky of arbitrage. However, whether price in a good condition market may alleviate the inefficiencies is not clear in their model.
Hachicha (2010) still mentioned that the empirical studies also focus on detecting the existence of herd behavior in mutual fund managers. (Lakonishok, Shleider, and Vishny, 1992; Wermers, 1999). Lakonishok, Shleifer and Vishny (1994)'s studies showed that the small stock transaction in the U.S. small companies has slight herd behavior, which may due to less public information and lead the fund managers cannot determine the trading strategy.
Grinblatt, Titman and Werners (1995) studied and analyzed the scope of if the purchasing of mutual funds relied on their previous returns and the tendency to reveal herd behavior. Their research informed that the investment funds on momentum can show apparently better performance than other funds in average. Moreover, they still figured out that the tendency of funds are buying and selling in the same stocks in the same time period. Werners (1999) found that the stocks bought by the U.S. mutual funds shows more same period and lagged earnings. Thus, the herd behavior of it is rational which accelerated the reflection of new information in stock price and can stabilize the market.
Most of the past literatures are using different mathematic models to analyze if there is herd behavior existing in stock market or in business field. These models discussed the herd behavior in different aspects and based on different economic theories. Many models were taken in the past researches, but not all stock market has herd behavior phenomenon. The previous research did great contribution to this financial field. But I will try to test the theory in a bit different way. The hypothesis of my research is that there are herd behavior and speculation behavior existing in Chinese stock market. I will choose simple model from them but I prefer to take a survey or interview specific investors, and try to figure out the appearance of them.
Methodology and Research methods
The paradigm of my dissertation is positivism. The positivism paradigm is appropriate because the dissertation will be researched and analyzed in deductive ways. Furthermore, explanation of theoretical framework is provided and the prediction of hypothesis occurred, quantitative methods can be used to measure and test the hypothesis afterwards.
The theory framework of the dissertation is mentioned in the literature review parts. More precisely, I will base on the behavioral finance theory and focus on the psychological aspects, mainly concentrate on the speculation and herd behavior perspectives. My hypothesis is there is speculation behavior in individual investors in Chinese stock market that they accord to the herd behavior and some of them may overconfidence or conservatism as well.
To test my hypothesis about the speculation and herd behavior in individual investors in Chinese stock market, I will focus on the data from macroscopic filed of the 19-year-old Chinese stock market, the Shenzhen stock market and Shanghai stock market. To obtain the data from a specific time period and approximately analyze the Chinese stock market and try to find related information with decision-making of individual investors. I will use corresponding statistic software to analyze quantitative data, such as Eviews Software, if possible.
The most important part in my methods is doing a survey into individual investors. To do such a survey, I can collect the primary data from taking internet questionnaires to individual investors, to someone who is representativeness; I may take telephone interview or face-to-face interview to find out straightforward information and get what they really think. To start with, I will carefully design the questions because it may influence the result and I need to make sure that every variable I mentioned in the questionnaire is relative to my research and can hopefully do certain help. How to choose the sample is a tough question as well, there are different types of individual investors in stock market, to choose a specific perspective of them or to do a general questionnaire is what I should deeply think about and I will pay plenty of time on testing the samples. In general, I think that I will choose the people who have academic background so that they can have a good understanding on English questions. In another respect, there may be some participants send the questionnaire back with no-response. The further strategy and dealing methods should be concerned as well. Finally, the tests should be conducted for validity and reliability and useful information can be earned through it. To test my hypothesis, I will analyze the information and earned data objectively and reasonably, if some questions appeared, I will try to find a suitable way to figure it out.
It is not easy to reveal the limitation of the research before it finished. However, I can still self-examination about the research and try to predict the future questions. There are two main problems in the methods I uses in the research, questionnaire fatigue and non-response bias (Collis and Hussey, 2009). It is a rather common problem I may meet, so that the scope of the sample is very important. To choose which kind of individual investors and how to let them know that they are playing an important role in academic research is essential.
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