Academic journal article Journal of Financial and Economic Practice

Positive Feedback Trading in Chinese Stock Markets: Empirical Evidence from Shanghai, Shenzhen, and Hong Kong Stock Exchanges

Academic journal article Journal of Financial and Economic Practice

Positive Feedback Trading in Chinese Stock Markets: Empirical Evidence from Shanghai, Shenzhen, and Hong Kong Stock Exchanges

Article excerpt

ABSTRACT

This paper examines investors' trading behaviors in Chinese stock markets by studying five stock indices that cover Chinese common stocks in three stock exchanges-Shanghai, Shenzhen, and Hong Kong. Our empirical results suggest that there exists a significant positive feedback trading effect in the Shanghai A-share, Shenzhen A- and B-share, and Hong Kong H-share markets. No significant positive feedback trading behavior was observed in the Hong Kong Red chip stock market. Consistent with prior literature, our empirical results suggest that the positive feedback trading effect in Chinese markets is asymmetrical between market upturns and downturns and that stock returns exhibit positive autocorrelation at a low volatility level and negative autocorrelation at a high volatility level. This finding is attributed to wealth-related variation in investors' risk aversion level and to market segmentation in Chinese stock markets. In addition, we examine the impact of deregulation of the B-share market on trading behaviors and find that the asymmetric return autocorrelation pattern of the market has changed since the deregulation. This finding should be of interest to portfolio managers and policy makers.

JEL Classification: C12, C33, GIl, G14, G15, G18

Keywords: Asymmetric GARCH Model, Behavioral Finance, Chinese Stock Markets, Feedback Trading, Market Segmentation, Stock Return Autocorrelation, Volatility

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

Interest in Chinese stock markets has increased in recent years because China has become one of the fastest growing economies. In 2010, it became the second largest economy in the world. Since the Shanghai Stock Exchange was established on Nov. 26, 199O1, and the Shenzhen Stock Exchange was established on Dec. 1, 19902, Chinese stock markets have grown rapidly in market capitalization, number of listed firms and securities, and number of market participants. After twenty years of development, Chinese stock markets still differ from developed markets in some characteristics related to market segmentation, government regulations, and investor structure. These attributes have heavy influences in investor behavior, asset pricing, and investment strategies in China. Prior studies of Chinese stock markets have explored such topics as asset pricing (Eun and Huang (2007), Chan, Menkveld, and Yang (2006), Chen and Xiong (2001)), market segmentation between A- and B-share stocks, trading strategies (Naughton, Truong, Veeraraghavan (2008)) and stock price and return properties (Los and Yu (2008), Zhu (2006)). Few studies have examined investors' trading behaviors in Chinese stock markets, and the related results are mixed (Feng and Seasholers (2004), Chen et al. (2007), Ng and Wu (2007)). Unlike in developed stock markets, individual investors are major market participants and traders in Chinese stock markets.

Their trading behavior is one of the major forces that drive stock price movement in the markets. Understanding investors' trading styles and behaviors in Chinese stock markets is therefore of great importance for understanding Chinese stock markets' characteristics and for designing proper investment strategies. When the Chinese stock market became the second largest market in the world, an increased interest in Chinese stock markets arose among international portfolio managers and investors. The results obtained in this paper shed light on the behaviors of market participants in China and are of great importance to money managers and institutional investors. On the one hand, once they are informed of the existence of positive trading effects in Chinese stock markets, institutional investors can exploit naive individual investors, a pattern known as the smart money effect (Shiller, 1990). On the other hand, our findings imply to institutional investors that stock prices might vary widely from their fundamental value because of the large majority of irrational individual investors in Chinese stock markets. …

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