An Empirical Study On Investors’ Confirmation Bias And Information Reaction Mechanism

As market anomalies like over-reaction and under-reaction appear constantly, EfficientMarket Hypothesis (EMH, hereinafter) based on the premises of complete information,completely rational and complete market has been increasingly questioned. The harshhypotheses decide that EMH is not able to truly describe the decision-making behavior ofinvestors. As a result, it’s difficult for EMH to fully and rationally explain and predictvarious phenomena in financial markets, and the further development of financial theory alsomeets bottleneck. However, studies of psychology have brought dawn for the theorybreakthrough and have laid a theoretical foundation for investors’ decision-making behaviorresearch in the psychological perspective, which makes the study of investor behavior morerealistic and has more explanatory power and predictive power.Psychological studies have shown that confirmation bias can make investors morelikely to adhere to their prior beliefs both in the process of information gathering andinformation processing. And thus this can significantly affect investors’ decision-makingprocess, leading to systematic bias. If the new information is not consistent with their priorbeliefs, investors will have an inadequate response to this information, wrongly adhering toprior beliefs; if the new information is consistent with their prior beliefs, investors generallywill be rational to deal with this new information or overreact to it. With all the listedcompanies (excluding companies with more than one type of ordinary share) in bothShanghai and Shenzhen stock market from1995to2011as the research object, this researchquantitatively measures investors’ prior beliefs on stocks, and thus forms four types ofportfolio combining with standardized unexpected earnings. At last, for every single type ofportfolio, we get average cumulative abnormal returns of1-12weeks consecutively afterannual report digestion period. The results show that: a) Different form overseas researchfindings, investors’ confirmation bias in Chinese stock market is of asymmetry, which canaffect their reactions to new information on specific conditions. b) Investors’ informationreaction mechanism is a complex process, which is not only closely related with factors likethe type of information, market system et al., but also affected by investors’ confirmationbias and their prior beliefs. Therefore, in the analysis of market reaction to certaininformation, we must consider investors’ prior beliefs on specific listed companies andmarket future trend.This paper has two main contributions. First, for the first time, this research directly studies investors’ confirmation bias in Chinese stock market，using empirical method. Thiscan further confirm or disprove existing theories and hypotheses, but also contribute to findthe unique law that may exist in Chinese capital market. Second, starting from investorswhich are the main players in the market, and based on the psychological characteristic ofconfirmation bias, we further explore the impact of confirmation bias on investors’information reaction. This can provide additional evidence for the existing theoretical studies,and also profoundly reveal the information reaction mechanism of Chinese capital market.