LV Thạc sỹ_Empirical research on irrational behaviors of individual investors in vietnam stock market

1 NATIONAL ECONOMICS UNIVERSITY ADVANCED EDUCATIONAL PROGRAM ***************************** BACHELOR THESIS EMPIRICAL RESEARCH ON IRRATIONAL BEHAVIORS OF INDIVIDUAL INVESTORS IN VIETNAM STOCK MARKET ACKNOWLEDGEMENT Our dissertation would not be possible without the enthusiastic help of several individuals who in one way or another guided and supported us from preparation to completion of the study First of all, we would like to send our warm thanks to professors and all of staff members of Advanced Educational Program who always follow our research step by step to give us supports as needed Especially, we would like to express our utmost gratitude to our beloved instructor – Master in Finance Nguyen Duc Hien for his valuable and inspirational instruction despite his extremely busy working schedule We also would like to send our special thanks to people who work for trading floors or securities companies for their enthusiasm and supports as we implemented our survey in their work:      Mr … – deputy director of Thang Long securities company Mr… – Vice head of department of Foreign Trade securities company Mr… – Director of Viet Dragon securities company Mr – analyst and broker of An Binh securities company And other brokers at stock exchanges in Hanoi Last but not least, we would like to give our thanks from bottom of our hearts to individual investors, who not know who we are, but still spend their little time on answering our surveys, for us to be able to complete the interesting research TABLE OF CONTENTS ABSTRACT CHAPTER 1: INTRODUCTION Rationale Background of Vietnam stock market .7 Research objectives Research questions Significance of Research Research scope 10 CHAPTER 2: LITERATURE REVIEW 11 Standard Finance 11 1.1 Four Pillars of Standard Finance’s Model 11 1.2 Standard Finance Approach 16 1.3 Input Elements of Standard Finance 16 1.4 Limitation of Standard Finance 16 Behavioral Finance .17 2.1 Introduction of Prospect Theory 17 2.2 Behavioral finance .22 CHAPTER 3: METHODOLOGY 28 Data source 28 Questionnaire design 28 Sampling 32 Analyzing process 33 CHAPTER 4: DATA ANALYSIS AND FINDINGS 37 PART I: PROSPECT THEORY TESTING FOR INDIVIDUAL INVESTORS IN VIETNAM STOCK MARKET 37 Overview of individual investors in Vietnam stock market .37 Prospect theory testing in Vietnam stock market .41 PART II: BEHAVIORAL BIASES OF INDIVIDUAL INVESTORS IN VIETNAM STOCK MARKET 43 Behavioral Biases’ Frequency and One-sample T Test 43 The influence of personal factors on individual investors’ behaviors 50 Explanatory Factor Analysis (EFA) 56 CHAPTER 5: RECOMMENDATIONS 64 CHAPTER 6: CONCLUSION 68 APPENDIX: QUESTIONNAIRE REFERENCES 70 74 ABSTRACT If standard finance assumes that investors are rational, behavioral finance defines those people as normal ones If the former provides investors with techniques to maximize investment profits, then, the later discovers characteristics inside investors to help them avoid cognitive errors, which may cause financial losses Therefore, standard finance and behavioral finance supplement each other However, while standard finance has developed for a long period of time, behavioral finance is still a new concept for many investors all over the world In Vietnam, behavioral finance has just been introduced in recent years The most popular bias, which people can easily realize in Vietnam, is herding behavior For example, in 2006 - the booming year of Vietnam stock market, it was likely that everyone jumped in stock investment However, the root of behavioral finance as well as various biases in current Vietnam stock market has not been studied thoroughly Therefore, this research focuses on proving existence of cognitive errors and finding behavioral biases of individual investors in current Vietnam stock market Surveys are distributed to individual investors to get the primary source After analyzing answers of 231 individual investors in the market by running SPSS to calculate frequencies and apply explanatory factor analysis, the authors provide an overview of Vietnamese individual investors’ behavior In general, they are subject to prospect theory, and among other biases, the most common ones in Vietnam stock market are overconfidence, over optimism, herding behavior, and seasonality CHAPTER 1: INTRODUCTION Rationale In the late sixteenth century, there was a story of investment that shook all of the market and the investors - the story about tulip bulbs In 1593, tulip bulbs were firstly introduced from Constantinople to Holland by a man named Conrad Guestner Because of its beauty and difficulty to obtain, tulip became an instant status symbol for Dutch elite Realizing the profit-making chance in the adoration of tulip buyers, speculators soon joined the market Even to Dutch middle class, the obsession with owning tulips was so big that they were ready to sell everything they owned like their homes, live-stock or other essentials to acquire tulips At that point of time, they expected that the bulbs’ value would continue to grow Because of that expectation, the price of a single bulb at the peak of tulips frenzy reached to the equivalent price of several tons of grain, a major item of furniture or a breeding stock of pigs In 1636, all the tulip bulbs had very high price Even foreign traders jumped into the market and speculated Later on, however, in 1637, when the first speculators began to liquidate their tulips, the tulip prices dropped quickly They lost about 90% in value within only one month As a result, a lot of investors had to incur huge losses The story above is just one of the most typical investing stories about economic bubbles in history Not only did they happen in tulip bulb market, economic bubbles also occurred in real estate market (Real estate in Florida bubble), and especially in stock markets (South Sea bubble, Great Depression in America, dotcom bubble, etc.) So, besides the speculation, it is questioned if there are any other factors creating the bubbles in the markets If the answer to the question above is “No”, then, it leads to the discussion about the bubbles in stock market, the place having the biggest number of bubbles in the history Since the emergence of stock markets, investors and financial analysts have developed various numerical techniques to evaluate and forecast value of the stocks Those techniques belong to standard finance, which is based on an assumption that investors are rational and market is efficient Therefore, if investors are totally rational, and market is really efficient, only speculation cannot create bubbles in the market Then, why bubbles in stock markets still happened After the Nobel Prize in Economics of Daniel Kahneman for his study of Prospect Theory in 2002, behavioral finance became popular among financial practitioners and academics Behavioral finance is a science that involves sentimental factors in finance While standard finance assumes investors are rational, behavioral finance simply considers investors as normal people Many biases of investors were discovered and named afterward: over confidence, over reaction, mental accounting, herding behavior, and so on People then could comprehend that the over expectation to the potent of market and the herding behaviors of investors are the main causes of bubble in the market and push market up far away from their true value In other cases, irrational behaviors of investors can make stock price up and down abnormally Together with bias discoveries, suggestions to solve those biases have been also developed by the economists to help investors enhance their investment returns Although behavioral finance has grown approximately 40 years and developed worldwide, it is still a fresh field in Vietnam Therefore, the topic about behavioral finance drives this research to supply deeper look into behavior of Vietnamese individual investors In this research, the main focus lays on detecting irrational behaviors of individual investors in current Vietnam stock market Background of Vietnam stock market Vietnam stock market officially came into operation since July 20, 2000 with an establishment of Ho Chi Minh Stock Exchange (HOSE) Then, in March 8, 2005, Hanoi Stock Exchange (HNX) was inaugurated From only two companies listed in HOSE in 2000, the number of listed companies in Vietnam stock market at the moment is 682, with 313 companies in HOSE, 396 companies in HNX, and 27 companies in both of two stock exchanges The simple registration procedure and small initial investment requirement are the mains reason for the rapid growth of Vietnam stock market After 12 years of operation, Vietnam stock market has overcome many periods In particular, the period from 2000 to 2005 was start-up stage with modest capitalization, accounting for only around 1% of total GDP However, after booming period in 2006 and 2007, stock market capitalization came up to 43% of GDP Then, due to the difficulties in both domestic and global economy, together with the collapse of stock market bubble, stock market capitalization dropped to 18% in 2008 In 2009, a recovery from macroeconomics helped to raise stock market capitalization to 37.7% of total GDP That number in 2010 was 40% Nevertheless, 2011 was a difficult year for Vietnam economy in general and for Vietnam stock market in particular Due to high inflation, the government simultaneously tightened monetary policy and reduced public spending Therefore, Vietnam stock market was strongly affected with the market capitalization decreased to around 20% of total GDP at the end of the year At the moment, after the first quarter of 2012 with positive signals from inflation-reduction efforts of the government, Vietnam stock market is having slight recovery in term of both capitalization and liquidity In the past 12 years, people have witnessed Vietnam stock market’s abnormal up and down of stock price For example, in the 2006 bubble, price of every stock went up In contrast, in 2011, this went down, no matter how the business performances of companies were Theoretically, stock price depends only on available information in the market Hence, in the economic conditions and operating information of companies in 2006 or 2011, those abnormal movements of Vietnamese stock market may be the consequences of psychological factors of investors in market Research objectives Investors in Vietnam stock market are currently having much more experiences than 12 years ago Back to 2006, at the peak of the bubble, investors in the market were various in terms of occupation, age, education, etc Referring to that period, it may lead to a quick conclusion that a characteristic of Vietnam stock market was herding behavior of investors However, after the collapse of the bubble, the active participants in Vietnam stock market were adjusted That means, over the time, the characteristics of investors in the market have changed In this research, the main objective is to have a look into cognitive errors of individual investors in Vietnam stock market After detecting common biases among Vietnamese individual investors and relationship of those biases with personal factors of each investor, this study provides recommendations for investors so that they can adjust their irrational behaviors and enhance investment results Research questions In this research, the following questions are going to be answered: Is prospect theory applicable for individual investors in Vietnam stock market? Do behavioral biases exist in Vietnam stock market? If yes, what are those biases? How is the relationship between those biases and personal factors of individual investors? Significance of Research Behavioral finance is popular among financial practitioners and academics all over the world with a lot of discoveries about investors’ biases However, in Vietnam, this science is still new People mostly think of herding behavior when behavior of investors in Vietnam stock market is mentioned This research will provide broader and more systematic view about behavior of individual investors in current Vietnam stock market Not only concerning about herding behavior, the research also examine other biases, starting from prospect theory of Daniel Kahneman to biases such as overconfidence, over optimism, representativeness, loss aversion, regret aversion, and seasonality Therefore, together with standard finance, individual investors in Vietnam stock market can also use our findings to apply in their investment Research scope According to previous researches in the world, there has been no evidence showing the differences in behavior of investors due to geography Therefore, there would be no intention of implementing this research nationwide, and processing it at stock exchanges in Hanoi only Moreover, this work concentrates on finding out cognitive errors of individual investors in Vietnam stock market, so the methodology to collect information is primary source 10 CHAPTER 2: LITERATURE REVIEW In a paper named “Behavioral Finance versus Standard Finance, Mier Statman, whose research focuses on behavioral finance, wrote: “Behavioral finance is built on the framework of standard finance but supplies a replacement for standard finance as a descriptive theory.” The first part in this chapter is a review of standard finance, including its basic models, approach, inputs, and limitations Then, behavioral finance and its application are introduced in the second part and developed later in other chapters of the research Standard Finance Standard Finance has four pillars:  Modigliani – Miller Theorems (Capital Structure Irrelevance Principle), Merton Miller & Franco Modigliani  Modern Portfolio Theory (Mean–Variance Portfolio Theory), Harry Markowitz  Capital Asset Pricing Model, John Lintner & William Sharpe  Black – Scholes Model (Options Pricing Model), Fischer Black, Myron Scholes & Robert Merton 1.1 Four Pillars of Standard Finance’s Model From two tables above, although cronbach’s alpha for herding behavior bias is 0.639 that is acceptable, we could see an even higher alpha if H1 or H2 is deleted from the questions to calculate the alpha Therefore, we decide to omit H1 and H2 and remains only H3 and H4 in herding-behavior questions, then the new result is shown in the following tables: Table 3.1.9 Table 3.1.10 With only two questions H3 and H4, the Cronbach’s Alpha is 0.769 – it is a quite high indicator to ensure that the scales of H3 and H4 questions are meaningful to test herding behaviors of individual investors Hence, H3 and H4 will be kept to test the hypothesis about the behavior in Vietnam stock market 3.2 Running EFA model: According to the results of reliability analysis, only the questions C1, C2 about overconfidence bias; O1, O2 about over-optimism bias and H3, H4 about herding behavior bias have significantly meaningful scale to test the hypothesis of irrational behaviors of individual investors in Vietnam stock market Hence, in the part, we also use only the six variables: C1, C2, O1, O2, H3 and H4 to run Explanatory Factor Analysis (EFA) Table 3.2.1 Table 3.2.2 Table 3.2.3 Table 3.2.4 From the table 3.2.1, we can observe the certain correlations between C1 and C2, O1 and O2 and H3 and H4 Moreover, coefficient KMO in table 2.2.2 is 0.547 (> 0.5) showing that the model is appropriate Based on eigenvalue criteria (eigenvalue > 1), table 3.2.3 shows us only three factors that could be drawn from our variables From the reliability analysis, we also know that there are relatively high correlation between C1 and C2, O1 and O2 and H3 and H4, so three factors drawn from six variables is reasonable Besides, table “Total Variance Explained” indicates three first factors can explain 77.775% the variance of data After rotating components, the results are shown in the table 3.2.4 There are three components that can be drawn from Explanatory Factor Analysis:  The first factor including two variables H3 and H4 expresses herding behavior of investors The factor is called herd  The second factor including two variables C1 and C2 represents the overconfidence of investors The factor is named overcon  The third factor including two variables O1 and O2 shows the over-optimism of investors The factors is called overop CHAPTER 5: RECOMMENDATIONS After finding evidences of behavioral biases’ existence of individual investors in Vietnam stock market, we propose following recommendations for Vietnamese government and investors to minimize negative effects of cognitive errors in stock market and in investors’ decision making: a Government should enhance their control over the security market Since its foundation in 2005, Vietnam stock market has been developed for more than years Compared to the other market in the world, our market is still so young That is the reason why there are the problems relating to transparency of the market and accuracy of information Meanwhile, our research has indicated that one of the factors affecting on investors’ investing decision is the information from rumors, from brokers or analysts’ suggestion and from bulletin news of security companies Therefore, enhancing Government’s control over the security market is really necessary Specifically, there should be a specialized agency with powerful sanction to take charge of testing the faithful of information on the market such as: financial statements of listed companies; volume and price of positions on the market; and other information sources that could influence on psychology and behaviors of investors, then harm to the health of our market and create benefits for a small numbers of people b There should be training courses on behavioral finance for individual investors Even in the developed and efficient security markets, the behavioral traps still exist invariably through series of decisions of investors such as overconfident, over-optimism, herding, loss aversion, regret aversion and other biases These irrational actions of individual investors could happen systematically (it is called market behavior) and they could affect on the whole market for a prolonged period of time and make the market not reflect their intrinsic value However, if individual investors are trained about behavioral finance, they will be equipped a different prism to observe and to assess security market Investors will have insight knowledge about their investment environment and behavioral biases that could govern their investment decisions and have negative influence on their investing objectives and results Training courses on behavioral finances should be involved in training programs of universities/colleges about finance-banking, in financial institutions, and even State Securities Commission that often holds the training programs and grants certificates about investment analysis In fact, behavioral finance has been mentioned in some financial training programs but it is just in introductory level All we need to improve the analyzing and assessment ability of investors is specialized behavioral finance course with systems of behavioral biases: what are they, how many types of biases and how to categorize them, how to define them and how to avoid their influence in making decision process c Each individual investor should study behavior finance and understand their behaviors During interview process with individual investors, we ask them questions to test whether they are influenced by behavioral biases or not, and realize that most of them can not define the objectives of our questions as well as not have any notion about the different biases except herding behavior, because herding behavior seems to be the most obvious behavior in Vietnamese security market in the last time and it is also mentioned most in financial reports and articles Simultaneously, we realize that when investors have the definition about herding behavior, their actions become more prudent before information in market, rumors or suggestions of financial analysts to make decisions However, less or more, individual investors are finally affected by herding behaviors as the results we have found out in our research As the matter of fact, individual investors just know about behavioral finance in general is not enough, they need to know about it and understand their behaviors deeply They should take part in character tests to find out behavioral biases they tend to be engaged and then study how to avoid the biases during their making decision process Particularly, to individual investors who invest in big scales with diversified portfolios, it will be better if they could seek for themselves a reliable advisor, who will help them understand more about themselves and anticipate possible irrational behaviors, to build an adequate portfolio or adjust investor’s decision making to harmonize their investment objectives d Developing institutional investors in Vietnam stock market Psychological factors can influence on the behaviors of not only individual investors but also institutional investors Moreover, due to reputational risks and inconsistence of result measuring mechanism on market, institutional investors tend to participate in trading strategies which are likely to be in herding behaviors with other institutional investors However, institutional investors are the knowledgeable ones that are professional at gathering and analyzing information as well as keen on applying analyzing investment tools As the results, they still play an important role as giant players to partly help stock market stable and efficient In fact, counted to the beginning of 2010, there are only 15% institutional investors in Vietnam stock market while 85% of total investors are individuals These numbers show us the imbalanced structure of investors in Vietnam stock market compared to the foreign ones That is also the reason why Vietnam is judged as one of the most fluctuated stock market Therefore, it is necessary for Vietnam stock market to focus more on developing and diversifying institutional investors to restrain too much fluctuation of market Besides, the growth of institutional investors also creates a good chance for individual ones to choose for themselves professional portfolio managers – who will help the individual investors to limit their disadvantages in their investments such as managing and analyzing ability or capital potentiality e Enhancing transparency of information in Vietnam stock market Last but not least, the transparency of information in Vietnam stock market in particular and on other stock market in general has never ever been an old story Only transparency of information on stock market can make the market operate more efficiently and gain the confidence of investors on the market Once information on stock market is transparent, investors can trust more on information that is public on market instead of following rumors or behaviors of other investors and the market tends to be more stable in front of multidimensional information flows or variations of macro economy Therefore, it is inevitable to have an adequate mechanism to require information transparency of listed companies on stock market CHAPTER 6: CONCLUSION Besides standard finance, behavioral finance is also an important factor affecting investment return of investors In our research, we answered two questions regarding to behavior of individual investors in Vietnam stock market currently Firstly, Vietnamese individual investors are subject to prospect theory, which is the root of behavioral finance This theory states that investors tend to be “risk – averse” in situation involving gain and become “risk – loving” in situation involving losses With the discovery of existence of prospect theory, we continue to find out other biases of individual investors in Vietnam stock market Secondly, four other biases of Vietnamese individual investors are detected They are overconfidence, over optimism, herding behavior, and seasonality (Tet effect) Other biases, including representativeness, confirmation, regret aversion, and mental accounting, are also tested, but the results are not strong enough to prove their popular existence in Vietnam stock market Moreover, we also examine the relationships between personal factors of investors (gender, experience, education) and their level of biases According to our results, male investors tend to be more confident and have higher level of herding behavior than female ones About the experience factor, investors with more experience are less affected by herding behavior in making decision than ones with less experience In contrast, about education level, there is no clear evidence to prove a significant difference between behavior of investors with high education and behavior of investors with lower degrees After testing investors’ biases, we provide recommendations in order to help individual investors avoid current biases With the improvement in government’s actions and awareness of investors about behavioral finance, together with higher number of institutional investors and more transparent information sources, Vietnam stock market can become more efficient and therefore rational investors may have higher returns than current status However, due to the limitation of time and human resources, this research has not reached many related issues Our research can be developed further by finding the level of impact of each bias on investors’ behavior, the regression model to show the relationship between all the biases with the behavior of investors, or the causes of investors’ behavioral biases Those issues should be studied by more detailed questionnaire and open interview with individual investors APPENDIX SURVEY OF INDIVIDUAL INVESTORS’ BEHAVIOR IN VIETNAM STOCK MARKET Dear individual investors! We are senior students of Advanced Finance Program, National Economics University, Hanoi, Vietnam At the moment, we are implementing a research about behavior of individual investors in Vietnam stock market Therefore, we very much hope that you will spend your time to help us answer the questions below We commit that all of your answers will be kept confidential and used for our research only Thank you for your kind co-operation! PART I: GENERAL INFORMATION Full name: Sex: Male Date of birth: Contact information: Email: Cell phone: Female Occupation: Education: Under high school Degree High school Diploma Degree Bachelor Degree Postgraduate Number of years investing stocks years What is your stock investment purpose? Short-term profit Yearly dividend receipt Long term investment Others How is your return in stock market in 2011? Loss Neither gain nor loss Gain less than 50% Gain more than 50% PART II: DETAILED QUESTIONS Question -20: Please tick one box in each of the rows below under the expression that best matched your agreement: ( *Level of Agreement: 1- Totally disagree; – Strongly disagree; - Disagree; 4- Neither degree nor disagree; – Agree; – Strongly agree; – Totally agree ) Notions You are confident in your ability of forecasting stocks in the market 10 You believe that your ability to choose stocks for investment is better than other investors in the stock exchange 11 You have the same opinion with financial analysts that 2012 is a promising year for Vietnam stock market 12 If VNIndex decreases by 5% tomorrow, you believe that it will soon recover in the next few days 13 You believe that stocks of governmental enterprises are all undervalued in the Initial Public Offering (IPO) 14 Fund management X gained positive result in difficult time of Vietnam stock market (2008 – 2009) You believe in the profitability of this fund in the future 15 You believe that investing in stocks of petroleum industry will definitely Level of Agreement bring to you profit 16 Trading activities of big investors in Vietnam stock market affect your stock investment decision making 17 Emotion is a factor affects your investment activities 18 You quickly sell stocks which are having profit 19 You have a strategic investment plan and always follow that strategy Question 20- 24: Please circle the appropriate choice that best expresses your opinion in each of the following questions: 20 Imagine that you forecast price of stock A will decrease, but some information in the market claims that stock A’s price will increase in the next period How does the outside information affect your investment opinion and action? a, You still believe in your forecast and evaluation, so you not change your opinion about stock A’s price in the coming period, and sell the stock b, You will find more information and examine your forecast before making the decision c, The outside information affects a lot to your opinion You feel unpleasant with that information Therefore, you will find out more information to prove that your initial forecast is right 21 Imagine you have two cases need to be decided: Case 1: If you win a lottery with an award of VND 100 million and decide to invest that amount of money in common shares and bonds, how will you allocate your portfolio? a, 100% in common shares b, 50% in common shares and 50% in bonds c, 100% in bonds Case 2: If you have a saving account of VND 500 million and decide to invest that amount of money in common shares and bonds, how will you allocate your portfolio? a, 100% in common shares b, 50% in common shares and 50% in bonds c, 100% in bonds 22 You invested in 1000 shares of a stock with the price of VND 20,000/share, and forecasted that the price of this stock would increase in coming period As your forecast, price of the stock increased for a long time and went up to VND 30,000/share At this price, you were confused to sell the shares or not Finally, you decided to keep the stock with a hope that the stock price would continue to increase However, the stock price suddenly dropped to VND 24,000/share What are you going to next? a, Sell immediately You want to gain profit b, Keep the stock You want to wait for the stock price to increase again 23 Please circle the option you choose in following cases: Case 1: a, Decision 1: 100% of probability having VND 600,000 b, Decision 2: 60% of probability having 1,000,000 VND and 40% of probability having nothing Case 2: a, Decision 1: 100% of probability losing VND 600,000 b, Decision 2: 60% of probability losing 1,000,000 VND and 40% of probability losing nothing 24 In your opinion, does stock market’s transaction have big changes before and after Lunar New Year (Tet) holiday? a Yes b No Question 25: Please tick one box in each of the rows below under the expression that best matched your agreement in the importance of following information sources: (*Level of importance: – Totally unimportant; – Very unimportant; – Unimportant; – Neutral; – Important; – Very important; – Totally important) Information Source Financial Statements Macroeconomic information Proposal of financial analysts Rumor Level of importance Actions of other investors in the stock market REFERENCE Bodie, Zvi; Alex Kane, Alan J Marcus (2008) Investments (7th ed.) 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VIETNAM STOCK MARKET 37 Overview of individual investors in Vietnam stock market .37 Prospect theory testing in Vietnam stock market .41 PART II: BEHAVIORAL BIASES OF INDIVIDUAL INVESTORS