Feedback Trading Behavior In The Securities Market: Characteristics, Factors And Mechanisms

Feedback traders are a special class of irrational traders in financial markets.Theymake investment decisions according to the last trading price change rather than thefundamentalvalue of securities.They coexist with the rational traders in the long runand interact with them, which influences the formation process of asset prices andmarket stability. Chinese stock market is subject to the characteristics of emergingmarkets and running in the transition period.There exists uniqueness for thecharacteristics, factors and mechanism of the feedback trading in Chinese stockmarket due to some special market conditions and arrangements. Wewill explore thisin five different parts:First, we clarify the basic concepts and historical roots of feedback trading.Also, weconduct behavioral financial analysis on the psychological basis of feedback trading,considering the impact of cognitive biases and emotional bias. Furthermore, wediscuss the generation mechanism of feedback trading in investment practice.Then weintroduce the relative theories of feedback trading,including DSSW noise tradingtheory and behavioral asset pricing model (BAPM), both of what are the preludes andsource of feedback trading theories, also including the behavioral capital assetspricing model (BCAPM) and the behavioral intertemporal capital asset pricing model(BICAPM), which are based on the concept of partial equilibrium and generalequilibrium and provide a testable empirical framework for feedback trading. Weemploy the BCAPM and the BICAPM as the theoretical basis of this dissertation.Second, with BCAPM framework and EGARCH (1,1)-M model, we discuss thefeedback trading behavior differences among various industry sectors of Chinesestock market and extend the study of the feedback trading to a more micro perspective.Through analysis, we confirmed that the feedback trading effects in Shanghai stockmarket mainly stem from the energy, health care, consumer staples and telecomservices sectors, while the other six industry sectors have no significant time-varyingfeedback trading effects. The volatility and market up-and-down have different impacton thefeedback trading of energy,health care, consumer staples and telecom servicessectors. On the one hand, feedback trading behaviors of the consumer staple sectorinvestors are most sensitive to the volatility, followed that of the health care sectorinvestors. In telecom service and energy sectors, the sensitivities of feedback tradingto volatility are slightly lower.On the other hand, the feedback trading behaviors fromenergy and health care sectors are significantly asymmetric.Positive feedback tradingeffect is much stronger during the market decline than the market increasing. It's notthe case for the consumer staples and telecom service sectors. The timing of thepositive feedback trading effect is similar for the four sectors. The positive feedbacktraders dominate the market consistently during the period from2006to2009. Forother time within the sample period, it's not the case. Third, we adopt the BCAPM analytical framework and establish a GJR-GARCH(1,1)-M model to examine the differences of feedback trading behaviors amongvarious segmented parts of Chinese stork market. Our empirical studies suggest that A-share, B-share and H-share markets exhibit different feedback trading behaviors:(1)There exists significant feedback trading behavior in A-share and B-share market butnone for H-share and red-chip market.(2) Volatility and market up-and-down havedifferent effects on the feedback trading behavior in A and B-share markets. ForA-share market, positive feedback trading behavior depends more on the marketup-and-down. Once the market declines, the positive feedback traders will dominatethe A-share market. For B-share market, positive feedback behavior depends more onthe volatility. Positive feedback traders will dominates B-share market during theperiod with high volatility.(3) The feedback trading behaviors in the Shanghai andShenzhen stock markets have significant differences in the sensitivity. Compared tothat in Shanghai stock market, feedback trading in Shenzhen stock market is moresensitive to both volatility and market ups and downs.In other word, Shenzhen stockmarket is more prone to positive feedback traders than Shanghai stock market.Concerned about the horizontal differences of feedback trading behaviors among A, B,and H-share markets, we also introduce an empirical model modified by dummyvariables toanalyze the policy effects of two events. One is the deregulation ofB-share market, the other is the launch of QFII. Both have changed the marketsegmentation and the structures of investors in the relevant parts of Chinese stockmarkets. We concluded that:(1) B-share market,rather than A market, has moresignificant positive feedback trading effects after the access of individual investorsfrom mainland.And B-share market price tends to be more volatile. This change isprimarily attributed to the decrease inreturn autocorrelation, which is irrelevant to thevolatility change. And the change of autocorrelation lifts the thresholdvolatility abovewhich positive feedback traders dominates the market. Therefore, individual investorsfrom mainland of China consist of the main force of the positive feedback traders inChinese B-share market.Their irrational investment behaviorsdestabilize the market.(2) In short term (2~4years), the launch of the QFII has no significant effect on thefeedback trading pattern of the A-share market; in the long run,it lowers theautocorrelations irrelevant to the conditional volatility in Shanghai A-share marketand makes the market more prone to significant positive feedback trading effect. As tothe Shenzhen A-share market, after the launch of the QFII,there is no significantchange on the feedback trading behavior and volatility levels. The launch of QFIIenables the foreign institutional investors to participate the A-share markets and thisdoesn't destabilize the A-share market.Fourth, we analyze the effects of the introduction of stock index futures with the samemodel as we did in the analysis of the deregulation of B-share market and the launchof QFII. We find that after the introduction of the stock futures index, thecharacteristics of the feedback trading behaviors changes a lot in the A-sharemarket.The positive feedback trading has been alleviated to some extent, whichattributes to the changes in the sensitivity of feedback trading behavior to thevolatility levels. During the two or four years after the introduction of the stock index futures, the volatility sensitivity of the return autocorrelation decreased significantlycompared to the period before the event.Even if market volatility increases, thepositive feedback traders have no significant influence on the pricing of the A-sharemarket. The autocorrelations irrelevant to the volatility increase significant only in thetwo-year window. That increases the threshold volatility above with positive feedbacktraders dominate the market. In this indirect way, it limits the destabilizing influenceof positive feedback traders.Fifth, on the basis of BICAPM analytical framework and general equilibrium thoughts,we build an bivariate GARCH (1,1)-BEKK-M model and jointly examine thefeedback trading behaviorsin foreign exchange market and the stock markets. Ourfindings suggest: In addition to volatility and market ups and downs, covariancebetween the foreign exchange and stock markets is also an important factor which hassignificant impact on the feedback trading behaviors in the A and B-share stockmarkets.And its influence is larger than that of the volatility and the marketup-and-down. The covariance influences the Shanghai A-share market, ShenzhenA-share market and the Shenzhen B-share market more than the Shanghai B-sharemarket. The covariance works in the way as follows: When stock markets rise,Renminbi appreciates, or the stock markets decrease, Renminbi depreciates, positivefeedback traders will dominate in the Shanghai A-share market, Shenzhen A-sharemarket and the Shenzhen B-share market; When stock markets rise, Renminbidepreciates, or the stock markets decrease, Renminbi appreciates, positive feedbacktraders will dominate in the Shanghai B-share market.