DOES PROSPECT THEORY HAVE A CYCLICAL IMPACT ON STOCK RETURNS IN CHINA? EVIDENCE FROM CHINA’S A-SHARE AND B-SHARE MARKETS

This work investigates whether prospect theory (PT) has a cyclical impact on stock returns in China. Based on all the stocks in China’s A- and B-share markets from January 2000 to October 2023, we quantify the PT factor and investigate it under the Markov regime switching (MRS) model. The results show that PT has different cyclical implications for China’s A-share and B-share markets. First, in the A-share market, the PT factor exerts a stronger negative impact during bull markets, indicating that investors are more sensitive to perceived losses amid rising prices and optimistic sentiment. Second, in the B-share market, the PT effect is more pronounced during bear markets, reflecting classical loss aversion and risk-seeking behaviors under distress, particularly among institutional investors. Third, the A-share market exhibits highly persistent and longer-lasting bear regimes, while the B-share market shows a more balanced regime structure. These findings underscore the asymmetry of behavioral responses across market types and states, highlighting the explanatory power of PT in capturing investor-driven anomalies in China’s segmented financial markets.