Positive Feedback Trading,Investor Sentiment And Anomalies In Stock Market

As Capital Asset Pricing Model(CAPM),Arbitrage Pricing Theory(APT)and efficient market hypotheses(EMH)had become the building blocks of economics and finance since 1970s,more and more financial puzzles and stylized facts which cannot be explained by traditional theories come to light.Specially,mispricing,absence of autocorrelations,heavy tails,volatility clustering and excessive comovement are much more well-known that others.Because of their strong impacts on asset pricing and risk management,academics and practitioners pay much attention on them.As far as the theoretical research is concerned,they have been focuses until now.In the early stage of explaining stylized facets,economists felt safe ignoring irrational traders in most discussion of asset price formation,and irrational traders went by the name of noise traders.But with the development of economics and finance,more and more economists start to realize that noise traders,especially positive feedback traders can make price diverge significantly from fundamental values.Behavioral finance is a new approach to financial markets that has emerged,at least in part,in response to the difficulties faced by the traditional paradigm.It argues that some financial phenomena can be better understood using models in which some agents are not fully rational.Spontaneously,investor sentiment which is composed of cognitive bias behind the behaviors come to the focus of research.This paper combines the behavior of positive feedback traders and investor sentiment to investigate how"buy when rise and sell when fall" and traders’ cognitive bias affect the properties of stylized facts.In the first place,an empirical test is made to study the significance of positive feedback trading and its relationship with investor sentiment.The results indicate that the influence of positive feedback trading is significant in Chinese stock market and the activity of positive feedback trading depends on investor sentiment.Next,this paper adopts agent-based computational finance(ACF)to generate simulation data and checks up how positive feedback trading and investor sentiment affect the properties of anomalies.ACF is different from traditional approach,which adopts bottom-up modeling strategy and emphasizes heterogeneous agent’s interaction and design.Simulation data are obtained through building and running artificial stock markets.The results of the study show that the behavior of positive feedback traders and their other behaviors,including assets selection behavior and market-timing decision,can explain a lot of stylized facts.In the short term,the ratio of positive feedback traders and their adjusting speed have great influence on properties of stylized facts.Specifically,the higher of the ratio and the faster of the adjusting speed,the more price deviates from fundemental value and the more distribution deviates from normal distritution and the more obvious volitility clustering appears.In the long term,the properties of stylized facts are controled by the intensity of choice and realized profit.Market-timing decision will produce assets positive excessive comovement.As the intensity of choice gets higher,the properties of sylized facts get more abnormal or the state of abnormality lasts longer.The selection behavior of positive feedback traders is caused by several cognitive biases.When positive feedback traders are relatively more radical or more conservative,the sylized facts get more abnormal.