The Verification And Explanation Of "the Closing Effect" In China's Stock Market

The closing price of stock is very important in financial assets pricing, such as research on predicting the tendency of stock price, the calculation of open-end fund's net asset value, the pricing of block trade and OTC trade, and the calculation of the price fluctuation limit of a stock the next day. All of these are based on the closing price. According to EMH, the stock transaction prices are distributed as random walk, they shouldn't have a time tendency. But some researches related show evidences that the stock intraday transaction prices do have a certain pattern and tendency.All of these researches indicate that the stock transaction prices have an abnormal volatility and a high return at close around the world capital markets, which is called "the closing effect". This paper uses the comparatively recent transaction data to examine whether "the closing effect" exists in China's stock market. The result indicates that, China's stock market has "the closing effect" similarly. Comparing to foreign researches, China's stock market has a special phenomenon," the noon effect", namely stocks have high returns and volatility at noon. The reason is that China's stock has a unique transaction system. The stock market has an hour and a half break at noon, which causes "the noon effect".There are mainly four explanations to "the closing effect": the fluid demand, avoiding overnight risk, the price manipulation and the imperfect of the transaction system. All of these explanations have flaws more or less, and they cannot completely explain the phenomenon. Because all of them are based on the basic assumption of traditional finance that people are completely rational. This paper gives a new explanation based on the framework of behavioral finance. It indicates that the cause of "the closing effect" is that investors are irrational in the decisions making process. The direct reason is that they make mistakes such as overconfidence, overreaction, and the time preference and so on. Furthermore, prospect theory and limits of arbitrage offer a theory to explain "the closing effect"."The closing effect" aggravates the volatility of the stock market. The transaction system should be perfected further to avoid the abnormal volatility of the stock market. And the authorities should improve information disclosure rules of the exchange-listed firm to ensure the information disclosed exactly, punctually etc, so investors can avoid making mistakes caused by information asymmetry. In addition, this paper also suggests that investors should be taught to invest rationally.