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Positive Study of Herding Behavior in China’s Stock Market

Author: LiZhen
Tutor: QiPeiJin
School: Dongbei University of Finance
Course: Financial Engineering
Keywords: China’s stock market Herding behavior CSAD
CLC: F832.51
Type: Master's thesis
Year: 2010
Downloads: 232
Quote: 0
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Traditional finance theory is based on efficient market hypothesis, while empirical research in these years found that there is seriously irrational behavior in stock markets. Behavioral finance becomes a new hot topic, and herding behavior is a typical case. Herding behavior in stock markets is the phenomenon that market traders are influenced by others, ignore their own information, make similar decisions, which is reflected in asset price.Herd behavior, which is a financial market abnormal situation, will cause price fluctuation, information tide, and finance crisis seriously, blindly buy and sell, and harm the whole financial system even worst. Stock market in our country is only 20 years old and made up mainly of individual investors, so it is more susceptible to the hazard of herd behavior. To the whole stock market, individual investors are like drops in the ocean. it is very difficult for them to get the latest news and to make accurate judgments because of the various constraints. Except for individual investors, institutional investors will make the same mistakes by referencing to the others when they make decisions. So these people will give up their own ideas and try to believe the judgments of the so-called experts, or even people around them. If a large number of investors are disturbed by the noise and do what the others are doing to generate herding behavior, it will be very likely that the stock price to fluctuate abnormally. Therefore, this study has some theoretical and practical significance, and perhaps can have some reference or be the role model for future studies.When describing the concept and classification of herd behavior we separate them into types:non-rational herding behavior and rational herding behavior. To non-rational "herding behavior", investors are completely following others and do not have any their own judgments. While to rational "herd behavior", investors regard it as the optimal strategy because of the difficulty of gathering information, the existence of incentives and many other external factors. We usually think that, rational herd behavior sometimes will help investors to make choices to maximize their own interests, but non-rational herd behavior will only have adverse effects for investors.In the empirical part, the CCK model is used to make regression analysis for the monthly return on 304 stocks from February 2000 to June 2010. The regression analysis showed that in the stock market of our country, herd behavior does exists, and after further study I found when the market is declining, there is serious herd behavior, while in the growing market, there is no obvious herd behavior. This result may be due to, the investors’intense blindness when the market is falling.Next, the paper summarizes the causes of herd behavior, both external and internal, also certain causes specific to China only. Many studies have shown that information asymmetry is the main objective causes of herd behavior. Noise means the wrong message, specifically means the distortion of information in the course of the dissemination due to interference. Internal factors are mainly the psychological factors of investors, including excessive self-confidence, blindly following and so on. Of course, as an emerging market of a socialist country, China’s stock market has its own characteristics, and also unique causes of herd behavior, which are mainly in policy and market structure. As a socialist country, Chinese government regulation has a significant role in the market, which directly results in the high correlation between the market and the government policies. Besides, the size of most listed companies in China is small, and the number of blue chips is obviously inadequate.Then, for herding behavior’s adverse impact on the market, this paper presents a number of preventive measures, and gives different advices to different market participants. To avoid herding behavior and maintain the stability of China’s stock market, first we should create a more perfect investment environment, which is including improving the legal system and regulatory system, increasing the trade of stock index futures, stock options and warrants. Secondly, we should improve the quality of listed companies. Many a times, investors are short-sighted because they are unable to find suitable long-held stock. If there are many excellent performance companies in the market, then a large number of investors will follow the changes in investment philosophy. Finally, we need institutional investors to play a greater role. Enhancing the proportion of institutional investors can effectively reduce the blindness of investment.

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CLC: > Economic > Fiscal, monetary > Finance, banking > China's financial,banking > Financial market
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