Proximity Bias Leading to Psychological Barriers in Pakistani Stock Market at Index Level

Abstract

People seem to carry a behavioral bias in investing in the stock market. This is usually depicted in people's investment behavior that coincides with market behavior in different up and down. These can be called psychological barriers’ that are certain index levels (usually in multiples of 100) at which the market tends to stick before breaking out either up or down. This behavior is devoid of any rational explanation and has nothing to do with the market fundamentals. This paper explored whether proximity bias exists in the Pakistani stock market that could create ‘psychological barriers’ and create investors’ subjective perception of ‘something special’ about certain index levels. We carry out an empirical analysis of the KSE-100 index to investigate these up and down that relate to human psychology. We obtained daily stock price indices of these emerging markets from the beginning of 1994 to the end of 2011 consisting of 2610 time-series data points. The psychological barriers were set at multiples of one hundred, such as the 500-level, 600-level, 700-level, and onwards. For the KSE-100 indices which are at multiples of a thousand, such as 6000-level, 7000-level, 8000-level.Our results reveal that the index price did display signs of barriers in both the price level and conditional return dynamics. The barrier effects indicated in the results of this study show clear infrequencies in the price distribution and conditional return dynamics of the series over the period examined. This study does not claim to link the barriers to a particular causal effect, but the authors believe that the lack of a formal rational explanation does seem to indicate a behavioral underpinning.