Anchoring Heuristics, Attention to Risks, and Market Liquidity : A Regression Discontinuity Design

This working paper is written by Jerry Cao (Hang Seng University of Hong Kong), Wenlian Lin (Chinese University of Hong Kong, Shenzhen) and Yong Li (University of International Business and Economics).Market liquidity evaporation is often accompanied by investors’ attention to risks. We explore an anchoring heuristic behind this relationship by exploiting a unique setting in China’s stock market in which investors can promptly see whether the lock-holders of listed firms heavily engage in share-pledge financing. Using a regression discontinuity design, we find that investors use the pledge-day stock price, a piece of publicly available information, as the anchor to determine if they are paying attention to the liquidation risks of share-pledge loans. When the anchor is exceeded, investors especially small and retail investors become attentive to risks and stop to provide liquidity of such stocks. Our findings reveal the relationship between attention, panic and market liquidity spirals