The Downturn of Stock Market and the Irrational Exuberance of Leveraged Funds: A Case Study on Yinhuaxinli in SZSE

Abstract

Although the issuing of stock funds became increasingly difficult during the downturn in China’s stock market from 2011 to 2012, classification funds with leveraged character developed rapidly with the number of new funds growing and the shares of old funds increasing during this time. High leveraged funds such as Yinhuaxinli even developed into irrational exuberance. “Irrationality” was reflected in their trading prices having substantial premiums relative to their net values. “Exuberance” was not only reflected in their shares growing rapidly, but also reflected in their trading volumes and turnovers reaching one new record to another even when the whole market declined significantly. However, Yinhuaxinli’s special liquidation brought huge irreparable losses to its investors after its irrational exuberance. There are many reasons behind their irrational exuberance, and anchoring effect, sunk cost effect and gambler’s fallacy effect are the important ones. The lessons from such case study include not using leverage excessively and establishing a clear stop-loss point for leverage products.