Using comprehensive administrative data from China, An Li, associate professor at Tsinghua PBCSF, and co-authors Lou Dong (London School of Economics and Political Science) and Shi Donghui (Fanhai International School of Finance, Fudan University), investigated the substantial increase in inequality of wealth held in risky assets by Chinese households in the 2014-15 bubble-crash episode: the largest 0.5% households in the equity market gain, while the bottom 85% lose, 250B RMB through active trading in this period, or 30% of either group’s initial equity wealth. In comparison, the return differential between the top and bottom groups in 2012-14, a period of a relatively calm market, is an order of magnitude smaller. The paper was accepted by the Journal of Monetary Economics.

Wealth inequality has been rising over the past half century, with the wealth of super-rich people (e.g., the top 0.1% rich people) growing rapidly. Investment in financial markets may be an important factor behind this. In his best-seller Capital in the Twenty-First Century, Piketty emphasized that large blocks of wealth tend to earn a higher return than small ones. Similar conclusions have been drawn from previous studies on the Nordic and Indian markets.

There are three reasons why this is important. First, it is more difficult to predict who will win or lose in bubbles and crashes than in the ordinary market environment. Second, bubbles are often accompanied by price fluctuations and high trading volume, which makes significant wealth redistribution possible. Third, comparing to developed markets, financial markets in developing countries have more market fluctuations, so studying the impact of bubbles/crashes on wealth redistribution has important inspirations for the social welfare of these countries.

This finding also has important policy implications. International academic and policy hold a general view that encouraging the public to participate in investment in the stock market or risky assets is an important way to promote economic prosperity and social equality. This is especially important for developing countries with low market participation. However, the findings of this paper shows that if a large number of ordinary people with low wealth and investment levels actively participate in volatile financial markets, active trading is likely to bring them wealth losses. Policymakers should draw attention that for most ordinary investors, active trading often brings adverse wealth outcomes due to their disadvantages in investment levels and information acquisition capacities. Therefore, they should encourage ordinary individual investors to passively track the index or participate in the stock market through institutional investors, so that these investors can share the wealth growth in the capital market.

About the authors:

An Li

Associate Professor of PBC School of Finance (PBCSF), Tsinghua University, Deputy Director of Research Center for Capital Market and Corporate Finance. Her main research areas are asset pricing, behavioral finance and household finance. She has published papers in top international academic journals many times, and won many awards from academic circles, industry and governments at home and abroad, including the First Prize in Chicago Quantitative Alliance Annual Academic Competition, Dr. Richard A. Crowell Memorial Prize of PanAgora Asset Management, the 8th Outstanding Award for Scientific Research in Colleges and Universities (Humanities and Social Sciences) of the Ministry of Education, etc.

Lou Dong

Associate Professor of Finance from London School of Economics and Political Science, and a researcher from the Centre for Economic Policy Research. His main research areas are asset pricing and behavioral finance. He has published papers in top international academic journals many times and has won many awards for his research achievements.

Shi Donghui

Professor of Finance from Fanhai International School of Finance, Fudan University. With 23 years of experience in the securities market, he has served as Director of the Fund Market Department of Shanghai Stock Exchange and Director of the Capital Market Research Institute, and has participated in the design and implementation of a series of major reform measures and product innovations in the capital market. His main research areas are market microstructure, corporate governance, behavioral finance and financial market development policy. Dozens of his research papers have been published in well-known academic journals at home and abroad.