A Study Of Mental Accounting Effects On Individual Investors’Trading Decisions

As the development of the behavioral finance, Economists deeply analyze the unusual phenomenon of the financial market and individual investor decision and behavior. The prospect theory and mental accounting, as the most widely used cognitive decision theory, provide possible explanations for investor behavior. In prospect theory, individuals use an S-shaped value function to evaluate outcomes. The value function points out that people’s evaluation process is based on the deviating from the reference point, instead of the total wealth. Being defined over gains and losses, the value function shows diminishing sensitivity to both gains and losses. Mental accounting concerns the way investors evaluate outcomes using the value function. Diminishing sensitivity of the value function implies that individuals attain higher utility by evaluating losses together and gains separately. So if investors try to evaluate outcomes in whatever way that makes them happiest, then they prefer integrating losses and segregating gains, which is defined as the hedonic editing effect in the mental accounting theory.So that, we can infer that investors prefer to sell the stocks losses in the same day and sell the profitable stocks in the different days. Chinese stock market as one of the most important capital market in the world has many immature individual investors, whose investment decisions are always irrational. But there are relatively few empirical tests on whether and to what extent mental accounting affects investor decisions in china. So this article tests the effects of mental accounting on Chinese individual investors’trading decisions.Using the trading records of individual investors at a large discount brokerage house, the author found that investors are more likely to bundle sales of stocks that are trading below their purchase prices ("losers") on the same day than sales of stocks that are trading above their purchase prices ("winners"). Otherwise, this study also found that investors are more likely to integrate losses and segregate gains around the Spring Festival than in the other time. And this kind of phenomenon is more obvious in the bull market than in the bear market. At last, this paper tells us that compare with the male investors, the female investors are more likely to sell the losers in the same day and sell the winners in the different days.In terms of the structure, this article is divided into five parts. They are the research background, the literature review, the data processing procedure, the empirical analysis and the conclusion. From a new angle, this paper study the irrational trading decisions of the individual investors, empirically analyzing the effects of mental accounting on Chinese individual investors’trading decisions. Certainly, there are still some limitations, such as the data processing procedure is sketchy. So there will be still many issues in worth exploring, and we can further study this problem in the future.