A Behavioral Model On Stylized Facts Of Stock Market Fluctuations

Empirical studies on stock market fluctuations have revealed several stylized facts common to a variety of horizons and markets, including heavy-tailed return distribution and volatility clustering. Financial theories based on investor rationality and efficient market hypothesis cannot provide any solid explanation of such phenomenon. Since regulatory authority’s policy making and investor’s risk management depends on the comprehension of volatility, it is thus meaningful to study the causes of such stylized facts from both theoretical and practical perspective.Related literature is reviewed. This paper verified the existence of stylized facts in Chinese stock market. Investors’decision making process is discussed in the framework of prospect theory. We further established a model which captures observed behavioral characteristics of Chinese stock market investors and analyzed its simulation results. We conclude that:first, investors’response to fundamental signals demonstrates threshold behavior, resulting in overreaction when the signal is significant and underreaction otherwise, i.e. a heavy-tailed return distribution. Second, overconfidence and house money effect tends to aggregate overreaction, and it is also primarily responsible for volatility clustering.