Extreme market movements, the disposition effect, and subsequent return spreads: evidence from China

ABSTRACT

This study examines whether and how the interaction between extreme market movements and the disposition effect can affect subsequent return spreads between stocks with large paper losses and those with large paper gains for a sustained period of time. We study all the A-shares listed on the Shanghai Stock Exchange and the Shenzhen Stock Exchange. Based on the prospect theory, our results show that after extreme negative market movements, the disposition effect enhances significant subsequent return spreads; however, it generates insignificant subsequent return spreads when extreme market movements are positive.

KEYWORDS:

• Extreme market movements
• disposition effect
• subsequent return spreads
• China stock market

JEL CLASSIFICATION:

• G11
• G12
• G14

Disclosure statement

The authors declare no conflicts of interest.

Notes

¹ α is defined as the significance level.

² β is defined as the number of previous weeks that is used in estimating the corresponding VaR.

³ For more details, please refer to Shen et al. (2020).

⁴ For extreme movements in individual stock prices, please refer to Amini et al. (2013) for a detailed review of the literature.