The Economic Psychology of Stock Market Bubbles in China

Shujie Yao and Dan Luo

The World Economy, 2009, vol. 32, issue 5, 667-691

Abstract: The Chinese stock markets were extremely volatile during the period 2005–08. The Shanghai Stock Exchange (SSE) Composite Index increased more than sixfold from 1,012 in 2005 to 6,124 by the end of 2007. It then declined continuously to reach a low of 1,929 on 17 September 2008, or a drop of 70 per cent from its peak in less than 10 months. Although the market downturn may have been affected by the financial crisis in the United States and the rest of the world, the extreme fluctuations of stock prices signify a big market bubble, and the burst of that bubble must be explained by intrinsic characteristics or the economic psychology of Chinese investors. Based on a detailed market data analysis, this paper attributes the development of the stock market bubble to three key psychological factors: ‘greed’, ‘envy’ and ‘speculation’, and the burst of the bubble to three contrasting factors: ‘fear’, ‘lack of confidence’ and ‘disappointment’. It concludes that only after Chinese companies become really commercialised and profitable and investors become rational can the stock markets become stable without extreme volatility as seen in the past. Government policies can play a role in soothing market volatility detrimental to shareholders and the wider economy, but investors should not depend on government for making their own investment decisions.

Date: 2009
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