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Can the Greater Fool Theory Explain Bubbles? Evidence from China

Xuan Zou ()
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Xuan Zou: Rutgers University

Departmental Working Papers from Rutgers University, Department of Economics

Abstract: Many have noticed the phenomenon that naïve investors are attracted to the market as stock prices soar, yet few empirical studies have tested for this bubble phenomenon. This paper presents previously unused data on the aggregate number of newly opened brokerage accounts in China and tests the role of new investors in bubble formation. I find that new investors, attracted by soaring stock prices and the intensive trading activities of others, drove the Chinese stock market bubbles in 2007 and 2015, supporting the Greater Fool theory of bubbles. The inexperienced and naïve new investors appear more likely to be the "greater fools." Using the residual orthogonalization method, I build a data-driven structural model system, where shocks from the new accounts variable explain 40-55% of Chinese stock return variation.

Keywords: bubble; individual investors; volume; Chinese stock market (search for similar items in EconPapers)
JEL-codes: G1 G12 G41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cna and nep-tra
Date: 2018-08-28
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