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Can prospect theory explain anomalies in the Chinese stock market?

Author

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  • Ao, Zhiming
  • Ji, Xinru
  • Liang, Xinxin

Abstract

To measure the decisive role of prospect theory, we use a quantitative model to test 15 anomalies in the Chinese stock market. The results show that when investors engage in prospect theory, two-thirds of the anomalies are made correct predictions within a reasonable parameter range. We reveal that prospect theory’s ability to explain market anomalies is primarily driven by loss aversion and diminishing sensitivity in China. When factoring in prior gains and losses, retail investors do not demonstrate a predilection for gambling on “lottery-type” stocks. We quantify prospect theory’s impact on Chinese stock pricing, proving psychological factors can be measured.

Suggested Citation

  • Ao, Zhiming & Ji, Xinru & Liang, Xinxin, 2023. "Can prospect theory explain anomalies in the Chinese stock market?," Finance Research Letters, Elsevier, vol. 58(PB).
    • Handle: RePEc:eee:finlet:v:58:y:2023:i:pb:s1544612323008383
    DOI: 10.1016/j.frl.2023.104466
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    Keywords

    Prospect theory; Asset pricing; Market anomaly; Chinese stock market;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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