Price and Return,Which Matters?A New Explanation for Excessive Fluctuations in Chinese Stock Market
China's A-share market tends to overreact to information more intensely and frequently,resulting in stock prices failing to comprehend all information in a timely manner.Investors'overreaction leads to persistent sharp fluctuations in the market and rapid reversals of stock prices.Existed studies neglected the impact of price,the most fundamental variable in the capital market.In practice,investors are most frequently exposed to changes in the absolute prices,which also hold a dominant position in news websites and trading software.Based on the"ratio bias"in behavioral finance theory,this paper attempts to explain such overreaction from the psychological mechanism of investors thinking around absolute stock prices,being significantly meaningful for stabilizing stock market fluctuations,improving market pricing efficiency and enhancing the effectiveness of regulations.The Homo Economicus theory assumes investors to focus on returns rather than absolute prices,and similar events occurring in similar companies should trigger comparable reactions in terms of stock returns.However,this paper proposes that the absolute price misconception,arising from investors'excessive attention to absolute prices,leads to stronger overreactions in low-priced stocks.Referring to the amount of price changes after companies announcing events,individuals tend to expect comparable increase or decrease of the absolute price after observing similar events.Nevertheless,with lower underlying price of the target company,such price expectation implies irrational exaggerated yield expectation,causing the stock price to change excessively in the short term before falling back to the rational interval.As a result,low-priced stocks experience sharper fluctuations and faster reversals.Starting from the relationship between stock prices and volatility,this paper first confirms the existence of the absolute price misconception in the A-share market.In August 2020,the ChiNext market relaxed its long-standing 10％daily price limit to 20％.Utilizing this natural experiment,this paper employs the difference-in-difference method and the difference-in-differences-in-differences method to demonstrate the substantial increase in overall and extreme volatility in the reformed ChiNext market,primarily driven by low-priced stocks.There exists significantly negative correlation between stock prices and volatility in the reformed sample,which cannot be explained by size,returns and lottery-like stock characteristics.This paper further constructs reversal strategies in the reformed sample,illustrating higher monthly excess returns in low-priced stocks with the absence of influence from investors'lottery-like preferences.In an event study framework,low-priced stocks also realize higher abnormal returns on news announcement days,including quarterly earnings announcement and hot topic events,and exhibit weaker post-earnings announcement drift.An improvement in the quality of information disclosure can help to mitigate this effect.This paper contributes to behavioral finance literature by shedding new light on reasons of investors'overreaction,that is,the absolute price misconception,motivating by their greater emphasis on stock prices instead of returns.On the shoulder of pioneer studies of Shue and Townsend(2021),this paper further illustrates causal relationship between absolute price misconception and overreaction by comparing explanation power to reversal strategies returns of stock prices and lottery-like stock characteristics,representing investors'attention to stock returns.In addition,this paper is the first to discover empirical evidence of extreme volatility of low-priced stock in A-share market,and innovatively explores the impact of price limit and information disclosure systems on market anomalies.Considering that the illusion derives from excessive exposure to stock prices,this paper suggests regulators to guide the trading platforms and news media to emphasize returns,while organizing investor education activities to guide them in correctly understanding the relationships among news,returns and prices.Regarding market institutions,this paper recommends that policymakers set different daily price limits for stocks in different price intervals,and establish stricter standards for information disclosure by listed companies.
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