Date of Submission

Spring 2013

Academic Program

Economics

Project Advisor 1

Dimitri Papadimitriou

Abstract/Artist's Statement

In this project, time series regression models (Newey-West’s Model of Corrected Standard Errors and VAR model, etc.) are applied to prove the existence of bubbles in China’s largest A-share stock market (Shanghai Stock Exchange) empirically, while behavioral explanations are also given to supplement for the deficiency of the current econometric models of bubble detection purposes.

The results of our regression models show a significant correlation between the trading volume and the stock index, having controlled for the fundamentals. This indicates that herd behavior in China’s stock markets is one of the most important determinants for the excessive price change, hence proves the existence of stock bubbles driven by this herd behavior. Our VAR model indicates that Shanghai Stock Exchange A-share market is very much like a self-fulfilling prophecy that leads to investors’ overconfidence and drives up bubbles in China’s stock prices. Moreover, from the perspective of behavioral finance, the feedback mechanism, the investors’ overconfidence and wishful thinking, the announcement and disposition effects, the lack of short selling mechanism as well as other characteristics and restrictions of China’s stock markets also help to explain the herd behavior that causes bubbles in China’s stock prices.

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