In Search of Concepts: The Effects of Speculative Demand on Stock Returns

• Author: Iftekhar Hasan,Qingwei Wang,Ru Xie,Owain Ap Gwilym
• Published date: 01 June 2016
• Date: 01 June 2016
• DOI: http://doi.org/10.1111/eufm.12067

In Search of Concepts: The Effects of

Speculative Demand on Stock Returns

Owain Ap Gwilym

Bangor Business School, Hen Goleg, College Road, Bangor, LL57 2DG, United Kingdom

E-mail: owain.apgwilym@bangor.ac.uk

Iftekhar Hasan

Gabelli School of Business, Fordham University, New York, NY 10023, USA; and Bank of Finland,

00101, Helsinki, Finland

E-mail: ihasan@fordham.edu

Qingwei Wang

Cardiff Business School, Aberconway Building, Colum Drive, Cardiff, CF10 3EU, United Kingdom

E-mail: wangq30@cardiff.ac.uk

Ru Xie

Bangor Business School, Hen Goleg, College Road, Bangor, LL57 2DG, United Kingdom

E-mail: r.xie@bangor.ac.uk

Abstract

Using a novel proxy of investors’speculative demand constructed from online

search interest in investment concepts, we examine how speculative demand affects

the returns of Chinese stocks. We find that speculative demand increases following

high market returns and predicts subsequent return reversals. Moreover, the

speculative demand explains more variation in subsequent returns of A shares

(more populated by retail investors) than B shares (less populated by retail

investors). Our findings support the recently developed attention theory.

Keywords: investment concepts, speculative demand, investor attention, market

returns, trading volume

JEL classification: G02, G12, G14

We thank the Editor (John Doukas) and an anonymous referee for their help and guidance.

We also thank Franklin Allen, Chunxin Jia, Nancy Qian, Jianhua Xie, Wei Xiong and

seminar participants at the Princeton University & Peking University Symposium on

China’s Financial Markets for helpful discussions. We also thank Yizheng Wang for his

excellent research assistance. Errors and omissions remain the responsibility of the authors.

European Financial Management, Vol. 22, No. 3, 2016, 427–449

doi: 10.1111/eufm.12067

©2015 John Wiley & Sons, Ltd.

1 Introduction

Recent studies show that indiv idual investors tend to speculate in the stock markets and

hold stocks with lottery-lik e payoffs (Kumar, 2009; Dorn and H uberman, 2010; and

Han and Kumar, 2013). For thei r speculation to have a significan t impact on stock

returns, individual inves tors must trade on the same st ocks at about the same time

(Barber et al., 2009). However , there are thousands of stocks on th e market. Upon

which one(s) should they sp eculate? Froot et al. (1992) show th at short-horizon

speculators will attempt to l earn what other speculators also know. If we can track such

efforts, we can measure sp eculators’willingness to speculate and examine it s effect on

asset prices. Such a measure i s difficult to identify because those ef forts are typically not

observable.

We propose a novel measure based on individual investors’online search for

investment ideas and concepts. Arguably, investment ‘concepts’or ‘ideas’provide ideal

information for speculators to herd on, which may explain why speculative bubbles often

start with the emergence of investment concepts such as dot-coms during the internet

bubble. When such information is publicly available online, individual investors can

simply use search engines. Knowing that others can find similar information online,

investors know what they can herd. Google provides a search volume index to track

search intensity on certain keywords over a defined period relative to the total number of

searches during that period. Da et al. (2011) provide evidence that individual investors

are more likely to use Google to search for information than are professional investors.

Therefore the search volume index on the keywords related to investment ‘concepts’and

‘ideas’may reveal individual investors’interest in speculation.

Using a measure of investors’speculative demand constructed from the search volume

index in Mainland China on the keyword ‘concept stocks’, we examine how speculative

demand affects the returns on Chinese stocks. Concept stocks, prone to speculation,

typically rely on certain business and investment opportunities or the emergence of a new

technology. These stocks usually have highly uncertain growth prospects and are

difficult to value, which leaves more room for heterogeneous views and speculation.

Concept stocks in China are linked either with certain events or industries. The events

can be mega sport events, political events or major firm events (e.g., merger and

acquisitions). For example, the 2008 Beijing Olympic Games were believed to benefit

tourism, construction and retail businesses, therefore the stocks of related companies are

classified as Olympic-concept stocks. The dot-com industry and new energy industry are

two further examples related to concept stocks. Once the companies are classified as

concept stocks, they attract substantial investor attention and can become considerably

overpriced. Shanghai Maling is a frequently cited example of overpriced concept stocks

related to the dot-com industry in China. The company produces canned food for urban

area markets. In June 1998 Shanghai Maling set up a website for selling its own products,

and was subsequently labeled as an internet concept stock. While its main business

remained the same, the company’s share price soared from 149.96 Chinese yuan on

December 30, 1999 to 552.7 Chinese yuan on February 18, 2000 before tumbling 46%

four months later. In the literature, concept stocks are related to several heated

speculative episodes, including the biotechnology bubble in the 1980s and the dot-com

bubble in the 1990s (Hsieh and Walkling, 2006). These authors document the history and

performance of concept stocks thoroughly, revealing that concept stocks are overpriced

because they underperform in the long run.

©2015 John Wiley & Sons, Ltd.

428 Owain Ap Gwilym, Iftekhar Hasan, Qingwei Wang and Ru Xie