Sentiment or Sentiment-Related Feedback? Explaining the Persistent Pattern of Excess Comovement in China

43 Pages Posted: 10 Aug 2012 Last revised: 14 Mar 2014

See all articles by Jing Yao

Jing Yao

School of Economics, Fudan University

Date Written: March 12, 2014

Abstract

This paper investigates how individual investor trading can cause stock prices to move for reasons unrelated to fundamentals. We use a sample of dual-listed stocks to identify the sources of their price movements. The results show that excess price comovement driven by the market-specific shock is persistent over the monthly horizon for some A-shares traded in China, but not for their H-shares traded in Hong Kong. Further trade-based analysis indicates that the market-specific shock to the A-shares' prices may be initiated by individual sentiment changes, as proxied by the buy-sell imbalance (BSI) of individual investors (except the wealthiest individuals), but the mechanism for its persistence must be an indirect one. We then hypothesize and confirm a feedback view that the sentiment-related feedback of sophisticated individuals can strengthen the persistence of sentiment-induced excess volatility. We find that the monthly correlation in daily BSI between two investor groups, the wealthiest individuals and all individuals, is positively related to the shock at the monthly frequency. Meanwhile, the BSI of the wealthiest individuals is negatively related to the shock’s magnitude, suggesting that their trading behavior cannot be explained by an unawareness of the documented excess comovement but can be explained as the risk averse behavior of sophisticated investors. Our evidence and interpretation suggest that individual investors are more than a simple carrier of noise trading, and they can contribute to market inefficiency not only through individual irrationality, but also through individual rationality. We use the feedback view to shed light on several cross-country empirical anomalies.

Keywords: Investor sentiment; Individual investor trading; Strategic interaction; Excess comovement; Excess volatility; Sophisticated investor

JEL Classification: G11, G12, G14, G15

Suggested Citation

Yao, Jing, Sentiment or Sentiment-Related Feedback? Explaining the Persistent Pattern of Excess Comovement in China (March 12, 2014). Available at SSRN: https://ssrn.com/abstract=2127462 or http://dx.doi.org/10.2139/ssrn.2127462

Jing Yao (Contact Author)

School of Economics, Fudan University ( email )

600 Guoquan Road
Shanghai, Shanghai 200433
China

HOME PAGE: http://homepage.fudan.edu.cn/yaojing/

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