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Anomalies in Chinese Stock Market Empirical Research of Overreaction and Underreaction

Author: HaoWeiKe
Tutor: LvJiangLin
School: Jiangxi University of Finance
Course: Finance
Keywords: Behavior Finance Financial anomalies overreaction underreaction
CLC: F832.5
Type: Master's thesis
Year: 2009
Downloads: 246
Quote: 1
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Abstract


For a long time,as the representative of the financial classical theory,efficient market theory and CAPM have dominated the modern finance theory.However, opposite to the classical theory,some financial anomalies,such as closed-end fund puzzle,equity premium puzzle,the economy of scale,calendar effects,overreact and underreact,have constantly emerged,so that many scholars found it difficult to explain them with modern classical theories or models,and these financial anomalies begin to challenge the authoritative position of modern finance theories.Facing the challenges raised by the above financial anomalies,economists had to review the phenomenon of financial markets from other aspects.Off the beaten track, behavior finance analyzed the financial market anomalies from the perspectives of psychology and behavioral sciences,and explained,studied and predicted the capital market phenomena and problems,based on the micro-individuals and deeper psychological,social and other motives of such behaviors.The overreaction and underreaction occupied a central position in these financial anomalies,among which Debondt and Thaler’s article ’Does the stock market overreact?(1985)’,as the representative,triggered the revival of behavior finance.And as a new financial theory, the behavior finance theory got emerged from then.In this context,this paper describes the market efficiency and financial markets anomalies,as well as the contradiction between them,followed by a detailed review of relevant literature of the overreaction and underreaction,and then conducts a deep research on the overreaction and underreaction of China’s stock market,based on and bounded arbitrage theories.In this paper’s empirical analysis,the market adjustment model was adopted to calculate the cumulated abnormal return,to divided the holding period and test period with the use of overlapping holding periods method,and to construct the model with the classic ’winner portfolio’,and ’loser portfolio ’method.Using the most recent transaction data of China’s Stock Market from June 30,2001 to June 30,2009,this paper conducted empirical tests of the overreaction and underreaction from different perspectives,such as the long-term and short-term nontradable shares reform and investor heterogeneity.According to the logic of limited rational individuals- Cognitive bias -group behavior- financial anomalies- inefficient markets,combining the realities of China, this article conducted the theoretical and empirical analysis of financial anomalies from different perspectives,arriving at the conclusion that China’s stock market did exist the overreaction and underreaction,though indicating great differences in different situations.In the long run,China’s stock market did exist an obvious overreaction, particularly when the test period was over 12 months.And China’s stock market there was also an underreaction in a short term which was most obvious in the following one week;After the nontradable shares reform,this phenomenon had changed in some way, which was reflected in the less obvious effects of the overreaction and underreaction, while the underreaction was still significant in the long run;From the perspective of investors heterogeneity,small and medium investors showed a more obvious underreaction in the short term and a less obvious overreaction in the long run than those of institutional investors,which indicated that they were less rational.Finally,the paper made an explanation on China’s overreaction and underreaction, and proposed several suggestions which include that small investors should refrain from using momentum investment strategies and the government regulatory authorities should vigorously help the development of institutional investors,subject to investors and regulators.

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