The Formation of an Inefficient Market: Analysis of China's securities market.

Essay by coolchinese September 2005

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In the traditional MM regime, the security market is efficient and the investors are rational and always try to maximize utility. However, the cognitive psychology suggests that human decision processes are subject to some cognitive illusion . Given birth in 1980s', China's security market is one of the most unpredictable, controversial, fluctuated, and less regulated stock market, cognitive factors carry a lot weight in explaining this immature, mysterious, and attractive security market. This paper studies how behavior finance theories work in China security market, and try to explain the political, economics, culture, historical, and cognitive factors affect market price and people's investment habit.

Keywords: Behavior finance, China security market, inefficient

Research update

1.Theoretically efficient.

According to, Efficient market theory is a field of economics which seeks to explain the workings of capital markets such as the stock market. According to University of Chicago economist Eugene Fama, the price of a stock reflects a balanced rational assessment of its true underlying value (i.e.,

rational expectations); its price will have fully and accurately discounted (taken account of) all available information (news).

The theory assumes several things including (1) perfect information, (2) instantaneous receipt of news, and (3) a marketplace with many small participants (rather than one or more large ones with the power to influence prices). The theory also assumes that (4) news arises randomly in the future (otherwise the non-randomness would be analyzed, forecast and incorporated within prices already). The theory predicts that the movements of stock prices will approximate stochastic processes, and that technical analysis and statistical forecasting will most likely be fruitless.

2. Practically inefficient

The efficient process of price determination can be contrasted with an inefficient market, in which, according to the theory, the pre-conditions for efficient pricing (perfect information, many small market participants) have not...