Research On The ’Puzzle Of Idiosyncratic Volatility’ In China’s Stock Market Based On Prospect Theory

According to the traditional theory of finance,the high risk in the securities market requires payment of a risk premium to compensate。Therefore,in the real market,the idiosyncratic risk that cannot be eliminated by building a perfect portfolio should also satisfy the logic of“high risk and high return”.However,in recent years,some scholars have found a negative correlation between idiosyncratic risk and expected return in the empirical study,and there has been a "high risk and low return" vision.Afterwards,there are many researches on the phenomenon of “the mystery of idiosyncratic volatility” in the stock market,but there is no consistent understanding in the academic community.At the same time,other financial visions appearing on the market cannot be explained under the framework of traditional finance.This prompted scholars to explore the relationship between risk and income from the perspective of investor behavior.Behavioral finance came into being.This paper uses the idea of behavioral finance,based on the important theory of it —prospect theory,and separately studies whether the behavior of investors has an impact on the relationship between stock idiosyncratic risk and expected return from both theoretical and empirical perspectives.By reasonably quantifying the key variables in the prospect theory — capital gains overhang(CGO),empirical results are found using two-dimensional grouping and FM cross-section regression: There is an inverse relationship between the idiosyncratic risk and expected return in China’s stock market.When stocks are in the profit-making domain,his reverse relationship is further strengthened.In addition,taking into account the impact of split share structure reforms on the market,this paper uses 2005 as the cut-off point,and put the data into two parts.The results obtained after the sample data are tested in phases still support the above conclusions,indicating that the capital gains overhang of the stocks does affect the relationship between idiosyncratic risks and expectations.This article rationally explains the empirical results in sight of the development status of China’s stock markets,and is beneficial to further deepening the understanding of the importance of investor behavior.