Working Papers:

What Drives Stock Prices in a Bubble? 2023
with Weihua Chen and Donghui Shi

To shed light on the formation, expansion, and deflation of bubbles, we study how the cross section of stocks evolves during the 2015 Chinese stock market bubble. Using data on administrative account-level stock holdings covering a representative sample of 18 million retail investors and all institutional investors, we estimate a structural model of heterogeneous investor demand. The model allows us to attribute variation in stock returns to changing stock characteristics, changing investor preferences or beliefs, and the entrance of new investors. Improved stock fundamentals are initially key, accounting for 21% of the variance in cross-sectional stock returns during the formation of the bubble. In the expansion phase of the bubble, the entrance of new investors plays an important role, explaining 43% of the cross-sectional variance during the phase. Finally, the deflation phase is characterized by shifts in preferences or beliefs among existing retail investors, accounting for 25% of the cross-sectional variance in the period. We highlight the ways in which our structural model quantifies the forces in Kindleberger (1978)’s classic narrative.

 

Who Chases Returns? Evidence from the Chinese Stock Market, 2022
with Weihua Chen and Donghui Shi

Using data on 18 million individual equity accounts, we study retail investors’ return-chasing behavior. We construct a new measure for an individual’s return chasing propensity (RCP). Less sophisticated investors tend to exhibit higher RCP. Investors with a one standard deviation higher RCP earn 5.6% lower yearly returns on average. At the stock level, we construct a measure for a stock’s return chasing ownership (RCO) by wealth-weighting its retail holders’ RCP. Stocks with the highest RCO suffer 10% lower yearly returns on average. Return chasing predicts both investor returns and stock returns more strongly than various other investor characteristics.

 

In Preparation:

The Salience of Superstars and Negative Firm Profitability in IPOs
with Yang You

We document that the average firm profitability of equity issuers in the U.S. declined from 2010 to 2022 despite the increase in market valuations for these firms. This pattern is consistent with investors over-extrapolating the chance of profit-losing firms becoming future superstars like Google and Amazon. Using natural language processing methods, we find that profit-losing firms are more likely to promote themselves as future superstars and use hot topics like “network” and “sharing platform” in their IPO prospectuses. We demonstrate the interactions between investors’ behavioral biases and firms’ strategic responses.