Prospect theory and stock returns : Evidence from foreign share markets

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journalpeer-review

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Original languageEnglish
Article number101644
Journal / PublicationPacific Basin Finance Journal
Volume69
Online published27 Aug 2021
Publication statusPublished - Oct 2021

Abstract

Exploiting an exogenous regulatory shock in a foreign share market, we investigate its impacts on ownership structure and investor behaviors, and assess the ability of prospect theory to explain these behaviors and stock prices. We find that prospect theory values have strong predictive power for returns in the B-share market after the reform that attracts large inflows of individual investors. Changes in predictive power are driven by the probability weighting component in prospect theory value, reflecting the “lottery-type” demand of these individual investors. Results provide direct evidence that individual investors are prone to the mental presentation effect when evaluating risk.

Research Area(s)

  • Diminishing sensitivity, Individual investors, Institutional Investors, Probability weighting, Prospect theory