Market-Wide Attention, Investor Behavior And Stock Returns

Limited attention theory holds that the ratio of attention that investors paid to the stock market is constraint to time, energy and expertise, and attention-grabbing events in the stock market can reconfigure the attention of investors, and thus have an impact on investor behavior. Signal and system model describes the process that signals set off from the source, get through the channel and final reach the destination. Based on the limited attention theory and signal and system model, using Chinese market data from RESSET database, this paper studied on the problem that how attention affects investors` behavior and stock returns, from the angles of time series and cross-sectional analysis. There are varies of attention-attracted events in financial market, while most of the exiting literature just choose one or two of them to do researches, which results in the differences among those papers. We can`t explore what causes the differences from exiting papers. We point out that the reason of those differences is different attention-attracted events play different roles which we call “layers” on the path of attention affecting investors` behavior and stock returns and investors` behavior are the result of all “layers” interaction. Therefore, in order to outline the precise mechanism of the information transfer procedure, to interpret the result of differences in the existing literature, this paper presents the concept of the market-wide attention, which can be divided into two levels. Empirical results support our theoretical analysis. In addition, researches on media attention mostly use cross-sectional analysis, researches on investor attention mostly use time-series analysis, while all market attention have time-series and cross-sectional effects. In order to compensate study gap and reveal the effect of attention, the paper analyzed how attention affect investors` trading behavior and stock returns from the perspective of cross-sectional and time-series angle respectively. Then we use Fama-Macbeth model to test if the three kinds of attention are risk factors of return. Final we test the investor behavior with mediation equation to find out the mechanism of attention affecting stock market.First, we analyzed the relationship between investor behavior and the first level of the market-wide attention which are index record events and media attention. Empirical results show the presence of attention driving behavior among Chinese investors. Specifically, four types of investors show net buying behavior following the high record event, which is called "chase". The chasing degrees vary in different investors and can be list in descending order as large investors, super large investors, small investors and medium-sized investors. Small investors and super large investors show optimistic attitude to the short-term decline in the market and tend to use contrarian trading strategies. Super large investors are also concerned about the long-time low record event and they tend to make decision of net selling which is called "sell." The regression results with the index record event and media attention are quite different. We find that investors tend to buy stocks with higher media attention. While the time-series regression results are showing heterogeneity. Small investors made net sell decision following media attention while the other three kinds of investors made net purchases decision. this difference in behavior comes from the difference of attention paid to the media attention components.Secondly, we did an empirical analysis on the second level of the market-wide attention——Investor attention. Results showed that the effect of investor attention is the result of the interaction between media attention and index record events. Investor attention has the same cross-sectional effect with the former two attention. While time series effects are heterogeneous that the large, medium and small investors tend to make a net buying behavior following increasing attention and small investors behavior is more apparent in the good time. Super large traders attention can’t make predictions about their transactions.Finally, we did empirical researches on the stock market and market-wide attention. First, using Fama-Macbeth two-step method we test three kinds of attention as risk factors of stock return. We find that the index record event, expected media attention and investor attention can be used to predict stock returns, while the unexpected media attention behaves conversely. This is because unexpected media attention works mainly through small investor and in all investors, small investors accounted for a relatively small amount of the transaction, which led to unexpected media attention could not reflected in the stock price. Then we use mediating equation to examine the mediating effect of investor behavior between stock price and market-wide attention. The results show four types of investor behavior mediating effect significantly. Small and medium-sized investor behave completely mediating Effects, large and super large investor behave partially mediated effects and the ratio of mediated effects were 89.76% and 70.17%. Mediating effect tests confirmed the mechanism of how attention affecting stock returns.