Research and Analysis on Herd Behavior of Individual Investors

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Research and Analysis on Herd Behavior of Individual
Investors
Zhuowen Chen
University of Miami, Florida 33146, USA
Email: chenzhuowen0113@163.com
ABSTRACT
Based on the development of China’s financial market later than the western markets, the professional level of
individual investors and market supervision are undeveloped than the western markets. In the process of capital
market gradually internationalization, China's individual investors are face some problems which will be reflected in
herd behavioral effects.
In the investment market, herd behavior refers to the phenomenon of individuals giving up their own ideas, and their
own information to make investment decisions consistent with the group's investment decisions. Generally speaking,
individual investors buy blindly when the stock trading volume clearly increases, but blindly sell when the stock
trading volume obviously declines that resulting in large fluctuations in stock prices. This paper analyzes the influence
of herd behavior on individual investors by two cases. It focuses on the particularity of China's financial market
analysis. It analyzes and compares specific positive and negative effects of the herd behavioral caused by individual
investors.
Individual investors should fully aware of their strengths and weaknesses on investment strategies. There is little
chance of absolute reasonable. In order to avoid losses, individual investors should improve their judge abilities and
keep a clear thinking. As for the regulators, they should increase investment education for individual investors,
promote rational investment, open markets and improve institutions.
Keywords: herd behavior, individual investors, positive and negative effects, financial market, fintech
1. INTRODUCTION
With the rapid growth of per capita disposable
income, Chinese's investable scale grows rapidly.
Therefore, the demand for wealth management
increased and the number of individual investors in
financial markets gradually expanded. The proportion
of individual investors in financial market is increasing
rapidly, so the behavior of individual investors has a
more and more great influence on the dynamics of the
whole market. It can protect the personal interests of
individual investors and promote the stable
development of China's financial markets to explore the
behavior of individual investors and master the
investment decision-making mentality of individual
investors.
It is generally believed that the impact of herd effect
on the market is divided into positive and negative
aspects. Herd effects accelerate the reflection of
information on market prices. On a positive prospect,
herd effects allow some reliable market information to
correct stray market prices more quickly than without
herd effects. That is to say, the market has become more
efficient. From a negative point of view, the herd effect
makes the market price change increase and the market
becomes more unstable. Through case studies and data
comparison, the investment behavior and characteristics
of individual investors in financial markets are
analyzed. The analyze the reasons and the impacts for
the herd effect on the development process of China's
Internet finance and real estate. And the relevant
suggestions are given, which is of great significance for
stabilizing financial markets.
The innovation of this paper is to explain the
influence of herd behavior by analyzing the more
characteristic cases of individual investor herd effect.
The case is analyzed according to the particularity of
the Chinese market. Internet finance is growing rapidly
in China, such as Balance Bao. What's more, individual
investors have a strong interest in Internet finance. But
Advances in Economics, Business and Management Research, volume 166
Proceedings of the 6th International Conference on Financial Innovation and
Economic Development (ICFIED 2021)
Copyright © 2021 The Authors. Published by Atlantis Press B.V.
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in recent years there has been a lot of negative news.
Another case is real estate. Individual investors start
investing in real estate relatively early, but as far as I
know, many individual investors invest in real estate
entirely because of irrational psychological factors
caused chaos in China's real estate market. Through
case studies, this paper makes suggestions for
individuals, organizations and managers. The aim is to
promote the stability and development of China's
financial markets.
1.1. Herd Behavior
A) Explain: Herd behavior refers to individuals
ignoring the information obtained, giving up their
different ideas from the public and making decisions
that are consistent with group behavior. Herd behavior
in financial markets refers to "chasing up and down".
The consequence of herd behavior is that most investors
trade in the same direction for a period of time. There
are three characteristics of this behavior, first is not to
consider personal information, the second is that the
behavior of investors is irrational, and the third is that
this behavior has an impact on the whole market.
B) Causes: The causes of herd behavior are divided
into the following. Firstly, it is very common for
individual investors tend to blindly follow the public to
avoid risk. Secondly, the particularity of China's
financial market induces herd effect. [1] First of all,
China's individual investors have a large number, but
low level of education. According to the data, more than
195 million people invested in the Shanghai and
Shenzhen stock markets in 2017, 43.81% had a high
school education or less. According to research that
individual investors made 70.4% of investment
decisions through friend introductions, expert
recommendations, and reading to get information.
51.5% of them trusted friend's messages.[2] We can
draw a conclusion that there is a general lack of
knowledge and experience among individual investors,
and that it why individual investors are more likely to
generate irrational emotions than mature institutional
investors. Then, there are some problems in the
disclosure of information of listed companies in China,
such as irregularities, institutional defects and lack of
related supervision. Obviously, individual investors in
china are in the information asymmetry environment
that generated a sense of non-trust. These investors trust
other people's information more than they do, so as to
choose to follow other people's investment decisions.
Finally, individual investors in China's financial
markets generally lack long-term investment strategies,
most of which are speculative. In 2017, individual
investors held a market value of about 5.9 trillion yuan,
with 82.01% of the stock traded and institutional
investors holding about 4.5 trillion yuan, but only
14.76% of the stock traded. [3] Therefore, it is
reasonable to think that these individual investors lack
long-term consideration. That means they want to be
able to profit from speculation in the short term. So,
they don't spend a lot of time studying the market, they
buy or sell with others.
C) Impact: This paper holds that the herd effect of
herd behavior can be divided into positive and negative
aspects. Positive is able to stabilize financial markets,
negative is easy to exacerbate price volatility, triggering
financial risks.
a) Positive: The positive effect is that it accelerates
the reflection of reliable information in the market price
to avoids overvaluation or undervaluation. To be
specific, when the market price does not correspond to
the value, the institutional investors will sell or buy the
stock, and then the individual investor adopts the same
decision. As a result, it accelerates the price return to
normal value. Hence, the role of information in the
market becomes more effective. This advantage of herd
effect has a great effect on the development of China's
financial market.
b) Negative: The negative aspect of the herd effect
is the disruption of the market order. Blind buying and
selling by investors can easily lead to price fluctuations
and bubbles. Some investors will use this investment
psychology to manipulate the market and make the
investment market unstable. Such a lack of rational
investment behavior can also cause market confusion.
Such a lack of rational investment behavior can also
cause market confusion.
1.2. Individual Investor Characteristics
The securities market is generally divided into two
categories of institutional investors and individual
investors. As long as the identity of a natural person to
carry out securities transactions of value of the
individual generally become an individual investor.
Individual investors make up a large proportion of the
Chinese market. Obviously, under the assumption that
investors are absolutely rational, the price of the stock
follows the market price completely. [4] However,
individual investors are at a disadvantage in terms of
information acquisition and investment knowledge in
China. Personal investment is difficult and is influenced
by irrational emotions.
1.3. The Development of China's Financial
Market
According to the China Household Financial Survey
Report, the average household financial assets in China
are 63, 800 yuan.
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Table 1. A comparison of the number of stocks, bonds, and futures trading from 1998 to 2017 [5]
1998（Hundred million yuan）
2017（Hundred million yuan）
Rate
Stock trading
23,544
1,124,625
4677%
Bond trading
76
9,879,660
12999453%
Futures trading
18,483
1,878,925
10066%
China has become an important player in the global
financial system, including banking, bonds and stock
markets. In terms of total assets, China surpassed the
U.S. in 2010 and the Euro zone in 2016, with the
world's largest banking system, with total assets of
268.76 trillion yuan ($39.93 trillion) as of March 2019.
On October 2019, 3,709 companies were listed on the
Shanghai and Shenzhen exchanges. The total market
capitalization of Shanghai Stock market reached 33.69
trillion yuan (US$4.72 trillion), while the total market
value of Shenzhen Stock market reached 22.24 trillion
yuan (US$3.11 trillion).[6] In securities investment
transactions, individual investment occupies a large
proportion. And the behavior of individual investors
influence by the public psychology, short-sightedness,
risk aversion, blind self-confidence, blind panic,
dependence on national policies, dealer plot and other
factors, showing herd behavior, preference for small-
cap investment and other behavior characteristics easily.
1.4. Case Analysis and Comparison
1.4.1. Cases of internet finance
By virtue of the advantages of low barrier to enter,
internet finance attracts a large number of financial
activists such as cash-strapped people. It challenges the
inherent model of traditional finance and attracts a large
number of investors. Internet financial investors have
continued to grow in recent years in the face of a
depressed capital market in China. For most individual
investors, the cost of identifying internet financial credit
level is too high because of limited channels. Therefor,
it is easy to cause a certain degree of information
asymmetry, which causes individual investors to make
herd behavior. In other words, information asymmetry
on internet finance can lead to the spread of the entire
industry, whether the decisions made by the followers
are correct or not and pose a risk to the entire financial
system.
For example, Yu’E Bao, which has grown rapidly
since 2013. Yu’E Bao is a product launched by Alipay
and Taizhong Fund on June 1,2013. In 2013, China's
stock market performs as a whole is negative and the
economy is down. At that time, bank deposit rates are
low, but the Yu’E Bao attracted a large number of
investors. This was reflected in more than 10million
users increase in one week and more than $700 billion
invest in the first quarter of 2015, making it the world's
second largest fund for managed funds. At present,
Yu’E Bao is still China's largest fund. Ant Financial
Services Group’s user size has grown by 110 percent
and the number of fixed-rate users by 210 percent in
2019 one year. [7] The main reason is that the entry
barrier of Yu’E Bao is very low as long as 1 yuan.
What’s more, the yield is higher than the bank's demand
deposit rate. So that anyone can participate it. However,
these individual investors tend to underestimate the
potential risks of Yu’E Bao. For example, the scale of
Yu’E Bao is greatly influenced by the changes of its
yield and consumer demand. Yu’E Bao's industry
competition risk is growing, such as WeChat, JD. com
and other enterprises are gradually introducing similar
internet financial products. [8] In the event of a wealth
management product with higher interest rates, the
Yu’E Bao user will be lost a lot. In the end of each year
during the shopping peak season Yu’E Bao will have a
huge redemption phenomenon due to its ready-to-use
model which results a significant increase in liquidity
risk. In fact, in China, Internet finance-related laws are
not perfect, the Yu’E Bao developed in the lack of
regulatory environment. For instance, Yu’E Bao can
provide fund service before they get th fund sales
license as an intermediary. Once the relevant laws put
forward, Yu’E Bao will face a huge risk.
The herd effect on internet finance can also be
reflected through the “Yu’E Bao sentiment index". The
Yu’E Bao sentiment index is based on the Yu’E Bao
business scenario, broken down the trading behavioral,
screening out the users directly or indirectly into the
stock market funds. After stripping the IPO, holidays,
earnings impact, construct the data to standardize index.
The Yu’E Bao sentiment index reflects the willingness
of Yu’E Bao users to participate in the stock market.
For example, when the Yu’E Bao sentiment index rises,
it means that the Yu’E Bao user's willingness to enter
the market increases. To look at this index from a
different perspective, it can also be said that Yu’E Bao
users are easy to trade in the same direction, easy to
appear sheep behavior.
1.4.2. The case of real estate investment:
The vacant rate is an important index to measure the
existence of herd behavior in the purchase of houses.
The international standard for the rate of empty houses
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is 10%. According to data from 1999 to 2006, China's
vacant housing rate is much higher than 10%. After
China's policy of eliminating welfare housing began in
1998, and consumers began investing heavily in real
estate which created a false boom. Therefore, I think
there is a herd effect in Chinese real estate a lot. [9]
When herd behavior occurs, and demand seeks to
increase rapidly. However, the change elasticity of
supply is very small, and the formation of a bubble
weakens the impact of real housing demand on prices.
Investors are too sensitive to real estate investment,
causing industrial fluctuations. In the end, it
destabilized the market.
Table 2 China's vacant housing rate from 1999 to 2006
1999
2000
2001
2002
2003
2004
2005
2006
Vacancy rate
41.13%
36.48%
34.78%
31.88%
28.46%
25.00%
25.00%
26.00%
Vacancy rate =（（vacant area of the new commercial house+vacant area of the stock house）/the total number of
houses）*100%
1.5. Suggestion
1.5.1. Individual investor perspective
A). It is recommended that individual investors
invest as flexibly as possible. The number of investment
products in the market is large, there are certain
differences and the operation of the market will change
at any time. The complexity is difficult for every
individual investor to know. Although herd behavior
may gain arbitrage opportunities in the event that there
are erred pricing errors in wealth management products.
Through this analysis, when the majority of individual
investors in the market approve of a strategy and adopt
the same strategy, it might cause negative results.
Therefore, it is recommended that individual investors
take full account of risks, flexible use of investment
strategies, control the risks in their own more
manageable range.
B). It is recommended that individual investors
improve their analytical judgment. Before investing in
financial markets, we need to learn certain financial
knowledge and investment skills to master the laws of
market change. Understand the laws of market
operation in order to have a cool head, make the right
judgment.
C). It is recommended that individual investors
develop investment plans when investing in financial
markets. Clear long-term goals, in order to truly achieve
sustainable economic benefits. Avoid irrational
investments caused by emotions in the investment
process by developing detailed, long-term plans. Thus,
in the changing capital market to avoid blindly tracking
other people's views, adhere to self-judgment, reduce
the negative herd effect.
1.5.2. Regulator, government perspective
A). It is recommended that the company accurately
locate the current situation of China's market
development, understand the characteristics and
development direction. Obviously, there is a level of
professional knowledge gap for China's investors, risk
appetite is different and investment decision-making
behavior is biased. Thereby, the regulators should
establish a diversified and standardized investment
strategy, launch a diversified portfolio, adapt to the
development of China's financial markets, meet the
needs of diversified investors, attract current individual
investors.
B). It is recommended that regulatory bodies take
full account of the different circumstances of market
participants and quickly establish complete and more
detailed legal norms. With the help of financial theory,
do a comprehensive analysis of the current situation of
China's financial markets including behavioral finance,
to find out the existing problems and solve them. On the
one hand, we should strengthen the financial knowledge
of individual investors, education, etc., to improve their
cognitive level. By analyzing and studying the
individual differences of investors, the psychological
factors of investors are systematically analyzed.
Negative herd effects can be avoided to some extent.
Compared with the financial markets of China and
developed countries, the financial markets of developed
countries are more developed, and the financial system
and norms are more detailed. Communication and
exchanges with other countries should therefore be
strengthened. There are some differences in the
financial markets of various countries, but there is also
commonality. Therefore, we can learn to refer to the
development experience of financial markets in
developed countries, and then develop a suitable mode
of operation locally.
2. CONCLUSION
This paper explains the meaning, causes and effects
of herd effects, both positive and negative. By
analyzing the cases of herd behavior in the development
of the Chinese market, this paper explains the influence
of herd effect on Internet financial investment and real
estate investment. In the case of Internet finance, herd
behavior is because of the universal characteristics of
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that internet finance attracted many individual investors.
The herd effect has promoted the rapid growth of
internet finance in China. However, due to large
liquidity and inadequate regulation, the negative impact
that increase the instability of the market cannot ignore.
In the real estate investment case, the herd effect makes
the housing demand increase, the price rises, and finally
disturbs the market order. By analyzing the impact of
individual investor herd effect on the market, these two
cases give us the enlightenment that not all herd effects
are negative. Actually, it is very difficult for individual
investors to be absolutely rational, so we should use the
"rational herd effect" which is make use of the positive
impact of herd behavior and avoid the "irrational herd
effect" which is avoid the negative impact of herd
behavior to promote the development of financial
markets. In view of the negative effect of individual
investors' flock effect, this paper puts forward some
suggestions for individual investors and regulatory
authorities. In addition to the complex investment
market environment and the need for individual
investors to be cautious, regulators also need to further
improve the system and open the market.
This paper focuses on the analysis of the case, but
due to the author's limited scientific research time,
funds, capacity, lack of data calculation support. It is
hoped that in future research, I can support the degree
of using "rational herd effect" and avoiding "irrational
herd effect" by calculating the specific data of positive
and negative effect factors such as different weights.
ACKNOWLEDGMENT
First and foremost, I would like to show my deepest
gratitude to my teachers and professors in my
university, who have provided me with valuable
guidance in every stage of the writing of this thesis.
Further, I would like to thank all my friends and parents
for their encouragement and support. Without all their
enlightening instruction and impressive kindness, I
could not have completed my thesis.
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