Motivation and research question
The aim is to show the behavioral elements of the Chinese capital market and act as reference for the investors. So as to be able to identify whether the Chinese stock market is influenced by various behavioral elements. The Chinese economic reforms are attributed to have largely contributed to the development of the Chinese capital market which in turn enhances the economic. In this dissertation we are going to focus on the overall picture of the Chinese capital market in the theory of behavioral finance in relation to the current economic measures put in place will be covered under the literature review. The other aspects that were not covered in this paper will be discussed under the literature gap so as to broaden the research ground. The discussion of the capital market data and various results will be covered under the methodology and later accompanied by the explanation of the results and conclusion for the factors discussed. The motivation behind this study is the fact that China has a rapidly growing economy that continuously increases its overall market share in the international platform. This is a significant achievement since it helps in building of political influence in international platforms.
The concept of behavioral finance is mainly derived from the integration of finance and other social science disciplines. This has brought out various aspects of the capital markets thus enhancing ones understanding of the concept of financial markets. Fama’s literature review was able to identify the core reasons behind the behavioral finance in that indifferences that were discovered took a similar shape to that of the under reaction in that originated from investors overreaction. Also Fama was able to identify that with improvement in the various methodologies in various studies and increment in time frame the various anomalies were able to disappear. He was able to point out the wrong conclusion reached at by the psychological perspective of the finance behaviors. He based the inconsistency in the anomalies to the lack of a basic psychological principle that seems to indicate that individuals in all instances underreact or overreact as presumed for the financial anomalies situation. Second to his criticisms is the fact that frontier research in the wide range disciplines point out that the initial claims of findings that are regarded as important are in most instances faced out by the findings of recent reaserch carried out. Market inefficiency is able to suggest that that various stock prices do not display a consistent pattern since stocks whose bid in on the rise by investors will reduce with time where as those which have been underpriced will increase over time. This therefore attests the fact that stocks are not easy to measure or predict as bubbles can either turn out positive or negative. The theory of financial efficient markets was at its peak given the introduction of using coherent expectations in the process of speculating asset prices. Financial theory is largely based on the fact that various academic and financial analysts are of the notion that various investors act rationally while taking in to account all details during the decision making process so as to come up with efficient investment markets. This is largely based on the modern portfolio theory and the capital asset pricing models (Drew, & Naughton, 2003).
Behavioral finance was seen as to have marked the clear shift from the use of financial analysis that are accompanied by various time series analyses to the indulgence in development of various psychological models that are based on human market behavioral characteristics. Given the many anomalies behavioral finance is able to capture the various financial fluctuations. The feedback models used for the financial market models is the price to price feedback mechanism whereby through the increased speculative price investors to heighten the public expectations thus leading to increased behavioral characteristics. Efficient market theory has indicated various flaws thus pushing for the employment of eclectic approach. The behavioral finance know how is essential in the gaining of insight in various issues such as stock market booms which witness their downfall afterwards given the fact that the behavioral characteristics of the capital market resemble that of human weaknesses. There exists various human behavioral theories such as prospect theory where by the basic human cognitive behavioral characteristic of human beings becoming risk takers in times of loss and risk averse in times of benefit is a regularity. This therefore influences people to place more emphasis in outcomes that are more certain instead of those that are more probable. The manner by which various investors frame the idea or problems in their minds is of great significance to the decision to be undertaken.
Basing on the current findings the Chinese capital market has witnessed a steady rise in the GDP figures with the three major aspects for the growth being investments consumption and export values. The most significant contributor to the to the capital market is investment whereby an increased number of investors lead to increment in the rate of scale participation in the china capital market. This places the market as a significant platform for with effective wealth management qualities that provide a secure ground for public investment to be undertaken. With the optimization of the Chinese capital market in terms of the investor structure various companies have been able to exploit the available platform this comprises of insurance and social security companies. Corporate and other general agencies are the domi9nating forces in the investor aspect of market capitalization whereas private sector and professional institution investor comprising of the remainder respectively (Kleinbrod, 2006).
The china capital market in relation to the current findings is shaped in a multi-level structure whereby the various objectives of the market include the strengthening of the mainboard, coming up with various strategies that swill ensure development of the various SME while ate the same time advocate for establishment of the ChiNext stock market while at the same time ensuring the establishment of the OTC market. This is reaching its realization given the fact that the number of companies being enlisted in the Chinese capital market thereby increasing the total market capitalization effectively. Currently the market is characterized by the increased intermediary industries which are on the trading in huge figures for the net capital securities.
The development of a centered capital marketing regulation system is a significant development towards the efforts being put in place to ensure improvement of the legal system being used in the capital market. This is purported to effectively deal with the increased illegal activities that are being experienced in the capital market. This enhances both accountability and transparency so as to avoid the systematic risk associated. The Chinese capital market is deemed as to have been comprised of self-regulatory organizations. This comprises of various exchanges, security associations, stock exchanges and security investors protection funds (Kleinbrod, 2006).
Most of the Chinese financial lending institutions have been enrolled in the risk based lending activities thus opening up new platforms that have not been exploited by china’s domestic banking systems which in turn open up the nation to a wider investments platform. At the same time china is heavily involved in external investments mostly abroad thus enabling its increased industrial expansion given its increased dominance in the advanced technology, natural resources and capital inputs.
The gap in this research is the fact that behavioral based reaserch in the capital market is effective in carrying out analysis of property. Therefore the aspect of human behavior becoming increased in a segmented market may lead to information asymmetry. Human behavior influence can therefore provide the proper strategy in the property investment sector so as to develop the capital market. Properties have the same characteristics as the stock markets in that they apply the ambiguity aversion biases and use under prospect theory so as to explain the existing irrationality phenomena which is based on the various irrational belief models. With the increased alteration to the property capitalization processes there exist increased investor risk aversion given the volatility nature of the property market capitalization. Human heuristics during the process of formulating a decision is a preferred strategy since it enables one to make rational decision thus providing the amicable solution to the problem at hand. This suggests that the research should consider the various forms of beliefs that are under uncertainty so as to collectively sum up the various human judgments carried out under uncertainty.
Data and Methodology
The data on stock prices on the t average price in one quarter of the Chinese capital markets will enable us look at the rapid expansion that is taking place and measures being put in place by the Chinese stock market body so as to prevent the capital flows from destabilizing the Chinese capital market. The Measures being undertaken include the establishing of separate share classes whereby local investors trade separately whereas the foreign investors trade separately. The foreign shares are traded at a cheaper price thus have a lower value comparted to the ones for the residential. The sample selection covers a DataStream in between 2006-2009 of shanghai and Shenzhen markets. This is also based on the size A and Size B share trading (Kleinbrod, 2006).
The Fama French model can be used to test whether the efficient market theory can explain the returns being experienced in the stock market. Efficient market theory is based on the fact that beating the market is next to impossible given the fact that stock market efficiency makes the current share prices to account and display all the information. This ensures that the investors are able to trade shares at their fair price since they cannot purchase undervalued stocks or sell stocks at higher prices. This therefore creates a capital market that cannot be easily outperformed through selection or timing (Kleinbrod, 2006). the data provided the shanghai and Chinese stock market for averaged stock prices in one quarter and earnings average of the last four quarters will be used in testing of my hypothesis so as to identify whether the Chinese stock market is influenced by behavioral elements. This data reflects the various decisions made by the investors. I will try to integrate the data from book values of the stock that are calculated from the financial statements while employing the Fama French model in the explanation(Kleinbrod, 2006)..
The sturdy will effectively employ the longitudinal study in that it takes the measurement of similar sample within multiple time points. This gives the study an ability to exploit the investor’s ability to solve various problems through carrying out of assessment in their behavior. The behavior aspect cannot be subjected to experimental testing therefore making longitudinal study the most effective methodology to undertake while conducting the research. In correlation to the internet surveys carried out on various investors it will lessen the work load of trying to find out the appropriate sample group.
The most key area of my reaserch methodology is carrying out of online research given the vast material on surveys carried out on individual investors in the capital market. The surveys are essential in that the investor’s feelings, behaviors and decisions can be easily assessed so as to determine the influence they had on to the decisions they made in the stocks(Kleinbrod, 2006).. My survey will be focused on the investors in the Chinese capital market as the sample group, this will enable me to achieve a wide range of investors over a short time frame. With a selected sample group I will employ the mail survey technique whereby I will administer to them an email attachment with various questions after which they will be expected to fill them and return. This kind of survey is cost effective and will be able to cover the investor strategy assessment thus proving to be vital in identifying the portfolio return of the investors. Dividend assessments and capital appreciations will be easily assess from the investor through mail sampling survey. I will be able to come up with relevant questions so as to touch on the main objectives of this research in that the questions will be in line with research variables. Given the wide range individual investors in the Chinese capital market it is essentially important to give a common approach to the questionnaire being administered (Kleinbrod, 2006).
The Fama and French model effectively described the stock prices of the chine capital market returns. This model utilizes three models, the classes of stocks that projected best results were stocks with low price to book ratio P/B and small caps.
The model suggests that small caps and value portfolios indicate higher expected returns. With regression carried out on Shanghai and Shenzhen AB indices indicate that Chinese investors had higher expectations in the returns Shenzhen’s return. Through regression the βA implies a negative price earning this therefore indicates that investors in the Chinese capital market are paying higher for the risky companies. This implies that βA should inhabit a negative correlation nature. βA shares portray a certain anomaly whereby a high beta company has the ability to showcase increased growth If the βA shares are added to the B shares E/p regression βA proxies indicate that there exist a positive correlation between growth and Ra. Therefore the lack of explanation as to the fact that Shenzhen and Shanghai have increased foreign relative prices is clarified. The overreaction hypothesis of the efficient market can be explained through the Fama French model in that during residual estimation of the model equilibrium. A smaller variation in the expectation in the securities returns is only relative to the market movements as depicted by the model. The Fama and French model on examination of shanghai and Shenzhen stock market for a five year period indicate the stock beak down from with regards to the coexisting serial correlation. This therefore points out the evidence that various stock returns can return themselves over a given time frame. The average Chinese stocks from Shanghai Shenzhen and Hong Kong stock are related to a firm’s book value to that of market value ratio in a positive manner. The 2006 to 2010 values indicate a strategy of choosing stocks with highest book price ratios thus the low price book values had an excess of 35 points in a single month. The Fama and French model analysis on the 2006 to 2010 cross section of the expected market returns indicate there exists a positive trend in-between book to price ratios and the markets average return value. Among the ten market portfolios existing firms with a low book to price (high P/BV) were able to achieve a monthly average return of 0.30% whereas firms with High P/BV were able to earn a market return of about 1.70% on monthly average. The average stock price in one quarter of the Shanghai stock significantly indicated rise in the final quarter of 2006 while indicating consistency in the rise to 2007 then followed by rapid fall in 2008. This is attributed to the behavioral characteristics indicated by the investors and the general price bubble in the stocks. The fact that investors are behind the changes in the stock prices the asset pricing bubble is definitely a reflection of the decision making process and beliefs of the investors. The investor’s emotions are deemed to have played a significant role in the bubble period as implied by financial markets state of mind. During the Chinese stock bubble it is evident that investor’s emotions played a significant role in driving forth their decision and the resulting decision which later resulted in stock prices leaving their fundamental value (Drew, & Veeraraghavan, 2004).
With regression having been carried out on various portfolios it was open that ranking of portfolios through Beta the projected correlation was that return values and Beta are not sustained. This therefore meant that no relationships can exist between the cross sectional returns and Beta. The relationship between the pricing ratios and the expected returns in the capital market indicate that the low ratio portfolios project higher returns. This is the same case scenario witnessed in the book value relationship that coexists between book value and the expected returns. In the asset pricing perspective the cross-sectional regression conducted indicated a variance in the residual from a given time series regression Chinese stock market is underway a flexible given the various policies put in place so as to restore investors’ confidence in the stock as indicated by the Shanghai stock exchange (SSE) data in 2007. The fact that foreign investors had the capacity to mount pressure on the regulators so as to secure QFII quotas easily impaired the capital market. The ability of the stock market to have hedge fund was an added advantage in that the index was able to rise to 8.1% in the first moth and indicated a rise by 3.1% in the following month. This showcased the impact of market reforms had to the capital market thus indicating the behavior of investors during the reform decision making process. Therefore market reforms acted as a strong reference for the investors in the Chinese stock market to the point that the foreign and institutional investors were flocking the stock markets. In any of the grouped portfolios the estimations of the asset pricings are never zero due to the existing value of the market capitalization arising from equity in addition deployment of the three factor model enabled the inducement of a near zero intercept of portfolios of a similar nature (Kleinbrod, 2006).
Behavioral elements heavily influenced the Chinese stock market in that they bring out the clear view of Eugene Fama’s empirical work where he attributed that in its weakest form capital market’s future returns cannot be forecasted basing on the markets past returns or any other associated attributes. Also in the semi strong markets the various market prices project the information that is in the public domain with regards to the economic fundamentals and all the financial content available. Lastly the model indicates that for the capital market in its strong form the prices project the existing public and private information that exists. This enables the stock to capture prices as in the SSE scenario. The Shanghai stock bring the aspect of subjecting each to earn equal regardless of the privilege of their information (Liu, 2010).
The RF-RM model in the Chinese capital market is effective when carrying out analysis of the beta correlation in the Chinese stock market returns due to the smaller stock proxies. Given the Chinese capital market portfolio the cross sectional and average returns can be estimated. This is attributed to the fact that there exists many small market portfolios which control about 360 billion dollars of funds therefore have had great impact to the market falls being experienced. The prediction of stock results in B-share index is easier compared to the A-share index in addition the level of efficiency in the Chinese capital market is lower compared to that of other developed capital market thus it accounts for the deficiency incurred during the spreading of information. The inefficiency has therefore led to the lack of adequate transparency being experienced in the capital market (Kleinbrod, 2006). Shanghai and Shenzhen stock exchanges suffer from the January effect whereby focus is created on both monthly and daily share returns. This therefore account for the anomalies in the Chinese capital market where shares higher shares trading is witnessed on Friday thus nurturing a short term trading behavior among the investors. The results of the described statistics used in carrying out predictions indicate that both the shanghai and Shenzhen stock exchanges there emerges various indifferences between the size A and size B in that Size A tends to generate a higher number of returns when compared to size B. this also accounts for the volatility of stock return of shanghai stock exchange being higher than that of the Shenzhen stock exchange. Therefore it makes it impossible for the both the stock markets to be in line with normal distribution thus bringing a skewed effect in the values(Kleinbrod, 2006)..
The test carried out on the January or the calendar effect given the fact that this capital market is a weak form efficient derived as a result of randomness in stock prices were based on a null variable hypothesis. The null hypothesis projected the effect in that all coefficients are equated to zero. The results for this basing on the average price in fourth quarter of Shanghai Shenzhen stock prices The A share and composite market indicated an increased in returns compared to those of B markets. A precise look on the month of Aprils stock returns indicate an emerging conflict to the January effect presumed in other stock markets such that the Chinese stock market tends to generate positive during April compared to January. In the daily returns perspective the stock suffers negative returns in Monday but experiences a steady rise during the week thus tend to inhabit a more predictable market behavior (Brien, 2007).
In conclusion in line with the efficient market hypothesis the Chinese capital market portrays a weak form of EMH. Chinese market is significant for this study since the market is getting more developed as a result of the quick growing Chinese economy with the availability of equitable market. This enables on to understand the market behaviors and investor decisions being made. The carrying out of human element assessment in the stock market is essential since the investors are referred as a result of their behaviors and relates to the strength the behavioral elements have to the capital market. The time series and cross sectional evidences discussed above are able to account for the distinctions between the size A and Size B share prices given that local investors pay about four times as much as the foreign investors.
Brien, J. (2007). Private equity, corporate governance and the dynamics of capital market regulation. London: Imperial College Press.
Drew, M. E., & Naughton, T. (2003). Asset pricing in China: evidence from the Shanghai stock exchange. Brisbane: School of Economics and Finance, Queensland University of Technology.
Drew, M. E., & Veeraraghavan, M. (2004). Pricing of equities in China: evidence from the Shanghai Stock Exchange. Brisbane: School of Economics and Finance, Queensland University of Technology.
Kleinbrod, A. (2006). The Chinese capital market performance, parameters for further evolution, and implications for development (1. Aufl. Ed.). Wiesbaden: Deutscher UniversitaÌˆts-Verlag.
Liu, C. (2010). Chinese capital market takeover and restructuring guide. Alphen aan den Rijn, The Netherlands: Kluwer Law International;