Herding Behavior and Market Overreaction in Chinese Stock Market

Abstract

The Chinese stock market is one of the largest and most liquid markets in the world, but it is also highly volatile. One of the main reasons for the high volatility is the large portion of individual investors in the market. Unlike in other major markets, the Chinese stock market is dominated by individual investors and not by institutional investors. When compared to the institutional investors, individual investors tend to prefer short-term trading strategies and react easily during times of high market volatility.

The purpose of this study is to identify whether the market-wide herding behavior has been present in the Chinese stock markets in 2007 - 2018. The study will also try to examine the reasons behind the phenomena and observe how and when the herding behavior occurs.

The CSAD (cross-sectional absolute deviation) method developed by Christie & Huang (1995) is used to detect market-wide herding. The studied sample includes 2766 observations from the review period (2008-2017) for 821 Shanghai A-share firms, 51 Shanghai B-share firms, 570 Shenzhen A-share firms and 52 Shenzhen B-share firms.

The results indicate that the market-wide herding behavior is present in the Chinese stock market. The results suggest that the investors herd around A-shares during periods of high market stress. There is also significant evidence that the herding behavior varies between different industries and time periods.

The differences in presence of herding behavior between A and B-shares indicate that the different investor base and experience in investing has an influence on the existence of herding behavior between the share classes.