Investor Emotions and the Psychodynamics of Asset Pricing Bubbles: A Chinese Perspective

Abstract

Between June 2005 and October 2007, when it peaked, the Chinese stock market rose five-fold. It then went into free fall losing 70% of its value over the following year, more than China’s total GDP. A similar trajectory played out between July 2014 and January 2016.This paper describes the powerful emotions unleashed during market crises of this nature. Specifically, we adopt a five-stage path-dependent model relevant to other bubbles and financial crises and test this empirically using the Chinese 2005-2008 stock market bubble as a case study. Results are consistent with investors experiencing a range of highly-charged emotions directly inter-related with different market states. Our evidence suggests that if we wish properly to understand and explain such destructive events we also need to recognise the vital role investor emotions play in their aetiology.

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