Heuristic decision-making and behavioral heterogeneity in the Chinese stock market

Abstract

ABSTRACT This paper applies a heuristic decision-making approach to a heterogeneous agent model (HAM) with two types of investors and use the heuristic HAM to investigate excess volatility in the Chinese stock market. In this heuristic HAM, we use simple moving averages instead of complex capital asset pricing models to assess the benchmark fundamentals which play an essential role in valuing the excess volatility of financial markets. We test the model using historical observations of China securities index 300. Our estimation results show that the model can replicate observed price dynamics and the estimated market sentiment matches the booms and busts well. Our analysis of the most volatile episodes, in particular, the 2008 financial crisis, the 2015 Chinese stock market crash, and the COVID-19 epidemic, further corroborates the existence of behavioural heterogeneity in the Chinese stock market. This work offers several implications for assessing the risk in financial markets and measuring the stability of the financial system.