Investor Irrational Selection Bias in Stock Market Based on Cognitive Psychology: Evidence From Herding Behaviour

Abstract

Contrary to efficient market hypothesis, real-world investors often commit irrational behaviors, such as the herding behavior, under market friction and psychological factors. Taking China's, A-share market as an example, this paper explores how investors' selection bias affects the herding behavior, and attempts to verify if the herding behavior is resulted from the psychology of loss aversion and the extrapolative expectation (the stock price will follow the historical trend). The results show that herding behavior is commonplace in China's A-share market, especially in severe bear markets, but not frequent in gentle bull markets; the research assumption is proved valid, i.e. the herding behavior is caused by loss aversion and the extrapolative expectation. The research findings reflect the influence mechanism of cognitive psychology over investor behaviors, shedding new light on investor education and market regulation.

Does Volatility Cause Herding in Malaysian Stock Market? Evidence from Quantile Regression Analysis

“…Nonetheless, rational herding receives major critiques from behaviour finance scholars (Mahani & Poteshman, 2008). Ye et al (2020) claim that herding is caused by loss aversion and extrapolative expectation due to the impact of cognitive psychology on investors' behaviour. Similar evidence is also presented in the study of Brown et al (2014) in which they prove that fund managers tend to herd to the revised target prices to achieve consensus.…”