Behavioral Finance Perspective on the Size Effect in China's Stock Market

In financial markets, the size effect manifests as the phenomenon where stocks of small-cap companies yield higher long-term returns than those of large-cap companies. Based on the efficient market hypothesis, traditional finance attributes the size effect to risk compensation, but this theory struggles to explain the uniqueness of China's stock market fully. Behavioral finance, by analyzing investor psychology and behavioral biases, offers a new perspective on the size effect. This paper systematically reviews the research history of the size effect in China's stock market and explores the impact of behavioral factors such as limited attention, overreaction, herding behavior, disposition effect, and market manipulation on the size effect. The study finds that China's high proportion of retail investors, significant market sentiment fluctuations, and strong information asymmetry amplify the role of behavioral factors in the size effect. From a behavioral perspective, this paper proposes investment strategies that consider the macroeconomic environment and institutional reforms to optimize stock market development, enhance regulatory capabilities, and provide theoretical references for market investors.