Knowledge that Transforms

We examine whether prominent behavioural theories – prospect theory, salience theory, and regret theory – help explain investors’ stock choices in the real world. Whereas prior studies rely on indirect tests based on the cross-section of stock returns, we study investor behaviour directly using approximately five years of comprehensive limit order book data from the Taiwan Stock Exchange. We find that aggregate investor demand, proxied by buy-sell order imbalance, is most consistent with regret theory. At the investor-type level, however, the evidence points to substantial heterogeneity: domestic individual investors’ trading is most consistent with regret theory, prospect theory has greater explanatory power for non-individual investors, and salience theory has predictive power primarily for foreign investors. Overall, our findings highlight the importance of investor heterogeneity and of accounting for investor composition when evaluating behavioural theories in financial markets.