Bridge over ocean
1 April 2015 CFA Institute Journal Review

Trading for Status (Digest Summary)

  1. Martin A. Wildy, CFA

An evaluation of household stock trading trends in China provides insights into risk taking and investor behavior. The authors examine the role that status plays in explaining puzzling retail investor behavior, including excessive trading in small local stocks. Location plays an important role and can lead to increased risk taking.

What’s Inside?

The authors focus on determining how local status in China influences retail investor behavior. They hypothesize that investors are motivated to match their neighbors’ wealth. This desire results in increased trading of smaller-cap stocks. The authors create a model and examine Chinese stock market data over a period of 14 years, focusing on turnover and market price differences for small companies relative to large companies. By incorporating household trading data and adjusting for regional wealth differences, the authors confirm that investors in high-status-concern areas take on more risk.

How Is This Research Useful to Practitioners?

Previous researchers have identified three factors common to retail investor behavior: first, excessive trading by retail investors results in worse financial performance; second, retail stock investments are biased toward small stocks or companies where the investors work; and third, investors chase high past returns. This behavior is driven by a host of behavioral biases, including overconfidence, sensation seeking, familiarity, and extrapolative expectations. The authors show that status concerns can reinforce behavioral biases and better explain retail investor behavior.

They do not find much evidence of status influence in China until after 2004. In 2004, a number of more developed cities reached a middle-class affluence, and status concerns became more important. The authors focus primarily on the relative trading activity and pricing of small-minus-big stocks. After controlling for a number of variables, they find that investors in high-status-concern areas trade small stocks more frequently than investors elsewhere, which also boosts the valuation of small, local stocks.

This research will be relevant to those interested in the field of behavioral finance and individual investor behavior. It will be of particular interest to those who invest in Chinese markets or provide financial advice to retail investors in China. Additional studies into whether this behavior is present in other global markets would broaden the research’s implications for advisers.

How Did the Authors Conduct This Research?

To conduct their research, the authors construct a model that is tested using Chinese stock market data from 1998 to 2012. The baseline unit of analysis is a city region. Province-level annual GDP per capita and population data are obtained from the National Bureau of Statistics of China. Monthly stock volume and pricing data are from China Stock Market and Accounting Research. The number of brokerage house branches located in each province is obtained from the Shanghai Stock Exchange.

To conduct their research, the authors run regressions of the data, focusing on differences in trading volume and pricing between small and big companies and regional variations. To confirm these findings, they also review household trading data using a sample of 300,000 retail accounts and trading data from January 2006 to December 2012. The authors run regressions on these data and control for a number of variables.

They argue that investors have an increased preference for small-cap stocks because they want to track their neighbors’ interest in local, private companies. Although the authors show that small stocks are statistically a better proxy for private firms in China than larger stocks, it is difficult to say whether retail investors are consciously using them as a proxy or whether small stocks are simply viewed as a quicker way to close any wealth gap.

Abstractor’s Viewpoint

Research that increases our awareness of behavioral tendencies of individual investors is important. Using China as a case study, the authors demonstrate that investor behavior varies by location, which they attribute to peer influence. Although there may be other explanations, the influence of status is plausible, and the authors make a good case for their hypothesis. I echo the authors’ comments that future work examining risk taking and status concerns in such other asset classes as real estate, as well as other global markets, would be helpful in determining whether this relationship is more universal.

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