To what extent can behavioural theories explain investor behaviour and asset return dynamics? Empirical evidence from real-world financial markets

Abstract

Behavioural finance has proposed several alternative theories of choice under risk. The thrust of the present thesis is to examine their ability to explain real-world investor behaviour and asset return dynamics. To this end, the thesis consists of three essays that analyse the patterns of returns in the emerging cryptocurrency market and the patterns of limit order submissions in the Taiwan stock market. Our findings contribute to our understanding of investor behaviour and the functioning of the cryptocurrency market.
The first essay explores to what extent prospect theory can explain returns in the cryptocurrency market. The study demonstrates that those cryptocurrencies that exhibit greater (lesser) appeal from a prospect theory perspective yield lower (higher) future returns. This outcome aligns with the theory’s predictions, suggesting that cryptocurrencies with higher PT values tend to attract excess investor demand, which may lead to overpricing and subsequently result in lower future returns compared to their peers with lower PT values. The prospect theory effect is both statistically and economically meaningful, and while the effect is stronger among cryptocurrencies that have more severe arbitrage constraints, it is not confined to the micro-cap segment of the market.
The second essay investigates the extent to which salient theory can explain investor behaviour and return dynamics in the cryptocurrency market. In line with the predictions, which imply that cryptocurrencies with salient upsides (i.e., high ST values) are prone to attracting excess demand, becoming overpriced, and generating lower subsequent returns, the findings reveal that cryptocurrencies that are more (less) attractive to “salient thinkers” yield lower (higher) future returns. Although the salience effect is both statistically and economically significant, it is confined to the micro- cap segment of the market, and its magnitude is moderated by limits to arbitrage.
The third essay examines the extent to which prospect theory, salience theory, and regret theory can explain investor demand in the Taiwan stock market, and whether their predictive power varies across investor types. The findings suggest that, at the aggregate level, investor demand is consistent with the predictions of regret theory. However, when the data are disaggregated by investor type, the results exhibit heterogeneity. Specifically, the behaviour of domestic individual investors is consistent with regret theory, while that of securities investment trusts is consistent with prospect theory. Additionally, foreign investors’ behaviour is consistent with both prospect theory and salience theory.

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Identifiers

ORCID for Rongxin Chen: orcid.org/0000-0003-2210-8824

ORCID for Chung-Ching Tai: orcid.org/0000-0002-2557-177X

ORCID for Gabriele Lepori: orcid.org/0000-0002-2619-227X

ORCID for Ming-Chien Sung: orcid.org/0000-0002-2278-6185

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