An Empirical Study Of Salience Theory In The Chinese A-share Market

Traditional finance theory has always occupied a central position in the field of financial research,based on the rational man hypothesis and frictionless markets,forming a systematic theoretical framework around the rational setting of people seeking to maximize utility.In reality,the validity and reliability of capital market anomalies are under attack,and the defects of traditional financial theory in explaining financial anomalies gradually exposed.Therefore,a new type of finance has emerged that incorporates features of the psychological discipline,called behavioural finance.It studies the impact of investors’ decision-making behaviour on capital markets from the perspective of cognitive psychology,which is important for explaining financial market anomalies,improving the effectiveness of asset pricing and promoting the development of capital markets.Influenced by the development of behavioural finance abroad,domestic scholars have also embraced behavioural finance with an open and inclusive attitude.Although China’s capital market has gone through more than 30 years of exploration and has become the second largest capital market,the unbalanced structure of market players and the large number of irrational behaviours in the market are still the main problems.However,the imbalance in the structure of market players and the abundance of irrational behaviour in the market are still the shortcomings of the domestic market.Bordalo et al.(2012)propose a novel theory based on Prospect Theory,Salience Theory,which can well explain the phenomenon that individual risk preferences change over time,and also help to explain mispricing in domestic and international capital markets.mispricing in the market.The empirical evidence in this paper has four main aspects: firstly,to research whether the Salience Theory can be applied to the A-share market,and test the existence of the Salience Theory.Constructing a long-short portfolio based on ST to examine whether the portfolio can generate significant returns for investors;secondly,to conduct bivariate portfolios based on firm size,book-to-market ratio,momentum effect and short-term reversal effect with ST to examine the existence of ST effect.The second bivariate portfolios is based on firm size,book-to-market ratio,momentum effect and short-term reversal effect with ST,to examine the prevalence of ST effect and whether it can be explained by alternative effects.The robustness of ST effect is also examined by running Fama-Mac Beth regressions on stock returns with ST and other control variables.Third,the persistence of ST effect in China’s market is considered by holding a long-short portfolio constructed by grouping deciles to observe the persistence of its prediction of future returns.Fourthly,a mechanistic analysis of the emergence of ST is conducted to examine the differences in the performance of Salience Theory effect across periods of market sentiment,and to analyse whether Salience Theory is an alternative explanation for the attention-driven effect.Based on the empirical findings of this paper,the following conclusions are drawn: First,there is clearly ST effect in our market.Investors overvalue stocks with salience historical returns,and thus these stocks are over-demanded to generate high valuations and lower future returns,while stocks with weak salience are undervalued and receive higher subsequent returns,with a significant inverse relationship between ST and expected stock returns.Second,ST effect is prevalent for both large and small companies,growth and value stocks.And ST effect cannot be explained by the momentum effect and the short-term reversal effect.Thirdly,ST will be present in the market for the next one to three months,but over time,people fade away from the stocks’ salience returns,thus correcting for mispricing.Fourthly,neither investor sentiment nor the attention-driven effect is the reason why investors pay attention to salience returns in the market,and Salience Theory is a separate phenomenon from these two factors.The innovation of this article lies in: firstly,it is found that the predictive ability of Salience Theory indicator ST is strong in the short term,but gradually weakens in the long term,providing investors with decision-making reference;Secondly,in further analyzing Salience Theory,this article compares it with the attention hypothesis and distinguishes the impact of salient historical benefits on investors from news media announcements.