Communication And Comovement: Evidence From Online Stock Forums
Lei Jiang
Tsinghua University
Jinyu Liu
Tsinghua University – School of Economics and Management
Baozhong Yang
Georgia State University – Robinson College of Business
June 29, 2016
Abstract:
We study investor communication and stock comovement using a novel dataset for an active online stock forum in China. We find substantial comovement among the returns of a stock and its “related stocks,” that are frequently discussed in the sub-forum dedicated to the given stock. Comovement is greater when related stocks are more frequently discussed. Further, the effect of frequent communication on comovement is stronger for stocks associated with higher information asymmetry. We also use a forum outage event as a quasi-natural experiment to establish causality. Our findings highlight the impact of investor communication on stock return comovement.
Communication And Comovement: Evidence From Online Stock Forums – Introduction
One fundamental question in financial economics is how asset prices are determined. In the rational expectations paradigm, price variations reflect changes in fundamental values. However, the empirical literature documents that there can be comovement in stock prices that is difficult to explain by fundamental values.1 Understanding the source and extent of comovement can shed light on the structure of asset prices and facilitate the design of portfolio management strategies.
In this paper, we study whether communication among investors can generate comovement of stock returns. It is usually difficult for researchers to observe the communication among investors. Using a novel dataset for online stock forums in China, we are able to directly measure investor communication. We document substantial comovement among the returns of stocks that are discussed together by investors on online forums. Such comovement cannot be explained by previously known reasons, such as market and industry factors, style investing, investor attention, or media coverage.
To motivate our empirical analyses, we develop a simple Grossman and Stiglitz (1980)–type model in which investors communicate before trading. The model shows that asset returns can exhibit comovement beyond what is implied by fundamental values when investors communicate repeatedly. The model also predicts that comovement in asset returns is positively related to the frequency with which investors communicate before trading. Intuitively, more frequent communication leads to a greater dependence of investor beliefs on common signals, resulting in greater comovement. Further, the model predicts that the effect of communication on comovement is more pronounced when investors have less accurate beliefs, that is, for stocks associated with greater information asymmetry.
We test these predictions using a unique dataset from the East Money Stock Forum, one of the most active online stock forums in China. The Chinese stock market provides an ideal environment to study investor behavior. Established in the 1990s, the modern Chinese stock market has developed rapidly but still witnesses irrational behaviors of individual investors (e.g., Xu (2000) and Wang, Shi, and Fan (2006)). While the importance of institutional investors has increased over time, individual investors still dominate trading. At the end of 2007, individual investors held 51.3% of the Chinese stock market by value, while institutional investors held 42.3%, and the government held 6.4%.2 Trading by retail investors accounts for the majority of trades in China and has been used to explain the high market volatility in 2015.3 In the Chinese stock market, individual investors frequently exchange information and ideas on online forums.4 While such communication can help to propagate and incorporate information into stock prices, it can also potentially lead to distortions in the market.
For any given stock, there is a sub-forum in the online forum devoted to exchanging ideas among investors. We refer to the stock that the sub-forum focuses on as its target stock. Investors are also free to discuss other stocks in a sub-forum. Based on our model, we expect the returns of the stocks discussed on the same sub-forum to exhibit comovement. To test this hypothesis, for any target stock, we consider the most frequently discussed stocks (henceforth referred to as “most related stocks”) on the target stock’s sub-forum. We construct a related portfolio that consists of the top five discussed stocks for every target stock and rebalance the portfolio each month. We then estimate time series regressions of target stock returns on the returns of their related portfolios to examine their correlations. We find that the average correlation between the returns of a stock and its related portfolio is positive and highly significant, even after controlling for known factors that drive comovement, including market, industry, and macroeconomic variables. This comovement is also economically significant; for example, a 1% increase in the related portfolio return is associated with a 0.21% increase in the target stock return.
To address the concern that the correlation may be spuriously generated by a temporal trend or comovement among industries, we conduct a falsification test. We first create for each target stock a placebo portfolio that consists of placebo stocks in the same industries of the related stocks. We then estimate the same regressions, replacing the returns of related portfolios with those of the placebo portfolios. We find the coefficients on the target stock’s return in the placebo regressions to be insignificant, suggesting that the comovement we document is unlikely to be caused by temporal or industry factors.
Online Stock Forums
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