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Prospect theory and stock returns: Evidence from foreign share markets

Junbo Wang, Chunchi Wu and Xiaoling Zhong

Pacific-Basin Finance Journal, 2021, vol. 69, issue C

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.

Keywords: Prospect theory; Probability weighting; Diminishing sensitivity; Individual investors; Institutional Investors (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.pacfin.2021.101644

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Pacific-Basin Finance Journal is currently edited by K. Chan and S. Ghon Rhee

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