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Exploration of the Interaction Mechanism between Market Pricing Bias and Stock Returns from a Behavioral Finance Perspective

Author(s)

Yifei Xu*

Affiliation(s)

City High School, Toronto, Ontario, M4V 1R5, Canada *Corresponding author.

Abstract

Traditional financial theory, grounded in the "rational agent hypothesis" and the "efficient market hypothesis," posits that market prices fully reflect all available information and that stock returns are solely determined by systemic risk. However, frequent occurrences of asset price bubbles, crashes, and anomalies (such as momentum effects and value effects) in real markets indicate that market pricing biases are ubiquitous and difficult to eliminate entirely through arbitrage. Behavioral finance, by incorporating psychological theories, uncovers the driving role of investors' irrational behavior in pricing biases and further delves into the dynamic feedback mechanism between pricing biases and stock returns. From a behavioral finance perspective, this paper systematically reviews the causes and manifestations of market pricing biases, as well as their impact pathways on stock returns, and analyzes how the interaction between the two contributes to market dynamic imbalances. The research finds that the combined effects of investors' cognitive biases, emotional contagion, and limited arbitrage create a complex mechanism of "self-reinforcement" or "mean reversion" between pricing biases and returns. This has significant implications for the optimization of asset pricing models and the design of market regulatory policies.

Keywords

Behavioral Finance; Emotional Contagion; Market Regulatory Policies

References

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