Empirical Evidence of Cognitive Biases among Chinese Investors

Abstract

The convoluted world of finance is filled with a number of irrationalities that the science of behavioral finance seeks to explain by bringing cognitive biases. Cognitive bias is a systematic pattern of deviation from rationality and is caused by limited cognitive capacities. By specifically analyzing Chinese investors, the paper aims to identify common cognitive biases exercised by high net-worth Chinese investors that lead to insufficient diversification and naive diversification in portfolio construction and to explain the following scenarios that are not commensurate with classic financial theories: the reason why investors prefer rule of thumbs instead of complete diversification; or when they do diversify, they simply takes N instruments and consider it done; the fact that people stick with a chosen stock or fund even when their prospects are not favored and other opportunity has arisen; and that investors from the same social background as a whole might have experienced certain preferences. And finally, when the cognitive biases are exercised by large enough of a population, stock market might suffer abnormal variances from it. The answers to these questions are studied by qualitative research methodology in this paper, narrative inquiry and inductive approach, to generalize and conclude to observed examples.