Reference-Dependent Preferences and the Risk-Return Trade-Off in China

Summary

This study replicates prior research on reference-dependent preferences and stock returns in China, using Capital Gains Overhang (CGO) as a proxy for investors’ unrealized gains or losses. It examines how CGO interacts with five risk measures: market beta, return volatility, idiosyncratic volatility, firm age, and cash-flow volatility. The stated sample covers Chinese stocks from 1995 to 2024, and the analysis uses dependent double sorts and Fama-MacBeth regressions to study cross-sectional returns.

The reported findings are that high-CGO firms show a weaker or absent positive risk-return relation, while low-CGO firms show stronger positive relations. Interactions between CGO and risk measures are predominantly negative in China, unlike the positive effects reported for the United States. The authors interpret this difference in light of China’s retail participation, speculative activity, and regulatory context, suggesting reference points may matter less there. These are replication findings for a particular market and period; the excerpt provides no detailed estimates or robustness tests, and cautions against assuming the pattern generalizes to other markets.

Key ideas

• CGO is used to proxy investors’ unrealized gains and losses in Chinese equities.
• The study tests CGO alongside beta, return volatility, idiosyncratic volatility, firm age, and cash-flow volatility.
• Its reported results show a weaker positive risk-return relation among high-CGO firms than among low-CGO firms.
• CGO interactions with risk measures are mostly negative in China, contrasting with reported U.S. findings.
• The authors suggest market structure and investor behavior may affect how reference dependence appears across markets.

Tags

# Replication of Reference-Dependent Preferences and the Risk-Return Trade-Off in the Chinese Market


# Replication of Reference-Dependent Preferences and the Risk-Return Trade-Off in the Chinese Market









This study replicates the findings of Wang et al. (2017) on reference-dependent preferences and their impact on the risk-return trade-off in the Chinese stock market, a unique context characterized by high retail investor participation, speculative trading behavior, and regulatory complexities. Capital Gains Overhang (CGO), a proxy for unrealized gains or losses, is employed to explore how behavioral biases shape cross-sectional stock returns in an emerging market setting. Utilizing data from 1995 to 2024 and econometric techniques such as Dependent Double Sorting and Fama-MacBeth regressions, this research investigates the interaction between CGO and five risk proxies: Beta, Return Volatility (RETVOL), Idiosyncratic Volatility (IVOL), Firm Age (AGE), and Cash Flow Volatility (CFVOL). Key findings reveal a weaker or absent positive risk-return relationship among high-CGO firms and stronger positive relationships among low-CGO firms, diverging from U.S. market results, and the interaction effects between CGO and risk proxies, significant and positive in the U.S., are predominantly negative in the Chinese market, reflecting structural and behavioral differences, such as speculative trading and diminished reliance on reference points. The results suggest that reference-dependent preferences play a less pronounced role in the Chinese market, emphasizing the need for tailored investment strategies in emerging economies.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.