Peer Effects in the Trading Decisions of Individual Investors
Ng, Lilian, Wu, Fei, Financial Management
This study examines for evidence of peer effects in the trading decisions of individual investors from Mainland China, a country whose cultural and social structures are vastly different from those of Western countries. Cultural differences, as widely documented, play a significant role in social interactions and word-of-mouth behavior. In contrast to US studies, we find robust evidence that the trading decisions of Chinese investors are influenced, via word of mouth, by those of their peers who maintain brokerage accounts at the same branch, but not by those whose accounts are maintained at another branch located in the same cir.
"People who interact with each other regularly tend to think and behave similarly." Robert Shiller (1995)
Peer effects have long been recognized in economic, psychological, and sociological literature as important determinants of individual outcomes. Theory suggests that in many economic and social settings, individuals can be influenced by the decisions of others, through "word of mouth" (Banerjee, 1992; Bikhchandani, Hirshleifer, and Welch, 1992; Ellison and Fudenberg, 1993, 1995; Cao and Hirshleifer, 2002; Banerjee and Fudenberg, 2004). Many financial economists believe that peer influences are important when explaining financial phenomena, such as banking panics and stock market crashes. (1) Recent empirical evidence has demonstrated that peer interactions affect investor trading decisions, as well (Hong, Kubik, and Stein, 2005; Ivkovic and Weisbenner, 2006). In the psychological literature, peer effects are a crucial environmental factor affecting developmental consequences, personality, and behavioral problems (Valliant, 1995; Curran, Stice, and Chassin, 1997; Dishion, McCord, and Poulin, 1999). Sociological literature addressing neighborhood effects indicates that neighborhood peer influences may be driven by evolving social norms and social stigma (Jencks and Mayer, 1990; Glaeser, Sacerdote, and Scheinkman, 1996; Katz, Kling, and Liebman, 2001). All these studies on peer effects and social interactions are primarily based on developed Western countries, especially the United States; hence, their evidence does not necessarily extend to other countries, particularly Asia, where cultural and social structures are vastly different from those of Westerners. Cultural differences, as widely documented, play a significant role in social interactions and word-of-mouth behavior (Brown and Reingen, 1987; O'Keefe and O'Keefe, 1997; Money, Gilly, and Graham, 1998).
In this study, we search for evidence of peer effects in the trading decisions of investors from an emerging Asian market, Mainland China. This particular market offers a couple of appealing features for our study. First, China has a unique investment environment that allows us to examine several implications of social learning theories that cannot be directly addressed using US brokerage accounts (data widely employed in existing studies). In Mainland China, individual investors are only allowed to open one account at any brokerage branch, and all trades must be placed through this specific branch. Groups of individual investors are typically in the same trading room when they place their stock orders. (2) Their close physical proximity naturally helps promote constant face-to-face interaction and word-of-mouth exchange of information. This unique setting offers a natural experiment on the impact of peer effects in financial markets.
Second, the Chinese have different cultural and social structures than those of Westerners. Lam and Lin (2003) study the effect of word of mouth in consumer purchases among Chinese and White Caucasians. They find that the Chinese group engaged in more word-of-mouth behavior than did their White Caucasian counterpart. They argue that this behavioral difference is associated with the Chinese cultural focus on Guanxi (meaning social relation in Chinese). …