1、Contrarian and momentum strategies in China stock market: 1993-2000 Joseph Kang * ,Ming-Hua Liu, Xiaoyan Ni Nanyang Business School, Nanyang Technological University, Singapore Abstract Using “A” shares accessible only to local investors (who account for 99% of stock investors in China), this paper
2、tests if short-horizon contrarian and intermediate-horizon investment strategies generate abnormal profits. We find statistically significant abnormal profits for both the arbitrage portfolio-investment strategies. Detailed analysis indicates that: (1) an absolute dominance of non-institutional inve
3、stors leads to an environment of excessive speculation and hence excessive overreaction to firm-specific information; (2) the overreaction to firm-specific information is the single most important source of the short- term contrarian profit; (3) the stock returns in the intermediate horizon exhibit
4、lagged overreaction to common factors; and (4) the lead-lag overreaction to common factor is the major reason behind the intermediate-term momentum profit. These findings are robust, among other things, to bid-ask spread and nonsynchronous trading. JEL classification: G14; G15 Keywords: Momentum and
5、 contrarian strategies; China stock market; overreaction and underreaction; firm-specific information; common factor; lead-lag structure. 1. Introduction An extensive body of finance literature documents that past stock returns can predict the future stock returns in short-term, intermediate, and lo
6、ng-term horizons, although the predictability weakens over longer horizons. For example, Jegadeesh (1990) and Lehmann (1990) find return reversals in relatively short-term horizons (one month and six months, respectively). Jegadeesh and Titman (1993) document return continuations in intermediate hor
7、izons (three to twelve months) where past winners continue to outperform, on average, past losers. DeBondt and Thaler (1985 and 1987) report long-term (e.g., three to five years) price reversals where past long-term*Corresponding author. Email: acskangntu.edu.sg; Tel (65) 790-4639; Fax (65) 790-3697
8、. We would like to thank for their valuable comments Lillian Ng, Andrew Chen, Joseph Williams, Qian Sun and Jack Chen as well as participants of the CREFS seminar at the Nanyang Business School in Singapore and the 13 thPACAP/FMA Annual Finance Conference in Seoul, Korea. We also acknowledge that an
9、 earlier version of this paper received the best paper award at the 13 thPACAP/FMA Annual Finance Conference.2 losers outperform past long-term winners. 1Given such time-series patterns in cross-sectional stock returns, one can formulate two arbitrage portfolio-investment strategies: contrarian and
10、momentum strategies. Under the contrarian strategy, past losers are bought and past winners are shorted. Under the momentum strategy, past winners are bought and past losers are shorted. Abnormal returns of these strategies are documented in the literature cited above. Abnormal profits of the moment
11、um and contrarian strategies are also documented in non-US equity markets. For example, Ahmet and Nusret (1999) find abnormal returns of long-term contrarian strategies in the stock markets of seven non-US industrialized countries. Chang, McLeavey and Rhee (1995) find abnormal returns of short-term
12、contrarian strategies in Japan stock market, whereas Hameed and Ting (2000) find the same in Malaysia stock market. Rouwenhorst (1998) finds momentum profits in twelve European equity markets, whereas Rouwenhorst (1999) finds abnormal returns of momentum strategies in six (out of twenty) emerging eq
13、uity markets. Hameed and Yuanto (2000) find that a (diversified country-neutral) momentum strategy generates small but statistically significant returns in six Asian stock markets. Schiereck, DeBondt and Weber (1999) find abnormal returns for both intermediate- term momentum strategy and short- and
14、long-term contrarian strategies in Germany equity market. Fama (1991) notes that the predictability of stock returns over time is among the most controversial issues on stock market efficiency. The controversy led to various explanations on the possibility and the sources of abnormal profits of cont
15、rarian and momentum strategies. The explanations include: one based on behavioral irrationality of investors and the other based on stock market efficiency.1In these studies, losers are those stocks whose returns are smaller than market index returns whereas winners are3 The most frequently-cited ex
16、planation of the abnormal profits of contrarian strategies is: markets over-reaction to firm-specific information and the subsequent correction. For example, Mun, Vasconcellos and Kish (1999), and Bacmann and Dubois (1998) posit that an overreaction to firm-specific information is the primary reason
17、 behind the abnormal profits of short-term contrarian strategies. DeBondt and Thaler (1985) argue that investors overreaction to recent past events also can lead to long-term contrarian profits. Lo and MacKinlay (1990) demonstrate that return reversal is not the only source of contrarian profits and
18、 identify second potential source of contrarian profits that arises when some stocks react more quickly to information than others. The alternative source of contrarian profits is referred to as lead-lag structure because the returns of some stocks lead the returns of others. Jegadeesh and Titman (1
19、995) and Boudoukh, et al. (1994) show that the lead-lag structure rather arises from investors overreaction or delayed reaction to common factors and also show that both the overreaction and underreaction (or equivalently delayed reaction) of prices to information can in theory contribute to contrar
20、ian profits. Another explanation is that short-term (and long-term) contrarian profits can result from time-varying common factors. For example, Conrad and Kaul (1998) argue that, even in frictionless markets, short-term stock returns can be auto- or cross-correlated. They argue that both the negati
21、ve autocorrelation in short-term individual stock returns and the negative cross- sectional autocorrelation are consistent with time-varying common factor. 2the stocks whose returns are larger than market index returns. 2The school of thoughts based on market efficiency also lists, as the reasons of
22、 long-term contrarian profits, mean- reverting expected market returns (e.g., Chan, 1988; Ball and Kothari, 1989), firm size effect (see Zarowin, 1990), and measurement error due to bid-ask bounce, non-synchronous trading, or illiquidity (see Park, 1995; Ball, Kothari and Wasley, 1995; Conrad, Gulte
23、kin and Kaul, 1997).4 The market-efficiency camp argues that time-varying common factors (or time-varying expected returns) and/or data mining lead to the existence of intermediate-term momentum profits. According to this explanation, the abnormal returns of momentum strategies are attributable to c
24、ommon factors that are not accounted for in CAPM or three-factor model. As Jegadeesh and Titman (1993) point out, to the extent that high past returns are partly due to high expected returns, winner portfolios will contain high-risk stocks that would also generate higher expected returns in the futu
25、re. Conrad and Kaul (1998) examine this possibility and conclude that momentum profits can be explained by cross-sectional differences in expected returns. Chordia and Shivakumar (2000) also show that momentum profits can be driven by time-varying expected returns that are in turn related to the sta
26、te of economy. In contrast, the behaviorists argue that the existence of momentum profits is a strong evidence of market inefficiency and it results from stock prices under- and over-reaction to information as well as investors herding behavior. Barberis et al. (1998), Daniel et al. (1998), and Hong
27、 and Stein (1997) develop models that appeal to behavioral bias and hence explain the stock-return continuations. In these papers, cognitive bias leads investors to either under-react to information or investors follow positive feedback strategies that lead to delayed overreaction to information. An
28、other behavioral explanation is herding. The tendency to herd among fund managers is a well-documented fact and it contributes to the profits of intermediate-term momentum strategies. See, e.g., Grinblatt, Titman and Wermers (1995) and Lakonishok, Shleifer and Vishny (1994). In this paper, we invest
29、igate the short-term contrarian and intermediate-term momentum strategies in China stock market. China is an important emerging economy that has just joined the WTO. 3Although the predictability in stock returns and its implications on3It has the largest population (1.2 billion) in the world. Its no
30、minal GDP (US$1.02 trillion) is the second largest in Aisa (after Japan) and the real GDP growth rate of about 8% is among the highest in the world. Its total trade is near5 portfolio investment have been extensively investigated in many emerging stock markets, China stock market still remains among
31、 the most important emerging markets awaiting such investigations. 4The lack of such investigation is mainly due to both the short history of equity trading in China and the lack of interests among global investors (who can invest only in the small and illiquid “B” shares market. 5The persistence of
32、 negative correlation between China and the United States as well as other developed equity markets will, however, increasingly attract the attention of global institutional investors. Hence, the investigation of momentum and contrarian strategies in China stock market is not only timely to global i
33、nvestment professionals but also interesting to finance academics doing research in the area of stock market efficiency. As stated in Hu (1999), the trading practice, composition, behavior of investors and regulatory environment in China stock market are very different from those in other markets. 6
34、Perhaps, the most interesting institutional feature in China stock market is the absolute dominance of individual investors as the main composition (99%) of stock market investors. See Shenzhen Stock Exchange Fact Book (1999).0.5 trillion US dollars which is about 60% of Japans equivalent. See China
35、 Securities and Futures Statistics Yearbook (2001). 4In 2000, China is one of the two countries whose stock markets are negatively correlated with the US stock market. See, e.g., Economist (16-22 December 2000, p. 90). 5Currently, there are two stock exchanges: Shanghai and Shenzhen Stock Exchanges.
36、 Since their establishments in early 90s, the respective exchange has seen sharp increases both in the number of listed companies and in the amount of market capitalization. As at January 2001, there were about 1,000 companies listed on the two exchanges with total capitalization of about US$590 bil
37、lion. Each exchange has two sections that are currently segmented: namely, “A” share and “B” share sections. The “A” shares are denominated in Chinese currency and issued only to (and traded only by) domestic investors. On the other hand, the “B” shares are denominated in US or Hong Kong dollars and
38、 issued only to (and traded only by) foreign investors. The “A” shares account for 99% of total market capitalization as at January 2001 and are actively traded. But, the “B” shares are not actively traded. Since February 2001, local investors are allowed to trade the “B” shares. But, under the curr
39、ent regulations on exchange control, local investors are still prohibited from converting their local currency to US or Hong Kong dollars for the purpose of “B” share investment. Given the current speed of liberalization taking place in China stock market and the entry into WTO, however, the segment
40、ation between A and B shares may disappear in not-distant future. 6There are studies (e.g., IPO study by Sun and Tong, 2000) that document special features of China stock market.6 There are several reasons behind the dominance of individual investors. Stocks and shares, long considered as financial
41、instruments in capitalist economic system, have been taboos in socialist China until recently. In early 1990s, the China government set up two stock exchanges as an “experiment” for economic reform. The “experiment” is yet to be completed before the stock market is ready for unlimited investment by
42、financial institutions. Another reason for the dominance is that too much money chases too few stocks. The inadequate social security system in China has led to individuals savings rate that is among the highest in the world. Due to lack of their access to treasury securities or corporate bonds, ind
43、ividual investors have no choice but to resort to bank deposits, stocks or properties. The bank deposit rates are often kept below the market equilibrium rate for the purpose of economic development,. Until recently, private ownership of properties was strictly regulated by the government. Hence, st
44、ocks are the favorite wealth-building instrument most preferred by Chinese individual investors. There are a limited number of shares that individual investors can buy. Since state-owned enterprises (often, heavily indebted) account for the majority of total market capitalization, there are only a h
45、andful of private companies being listed. With the state ownership being the corner stone of the socialist system, privatization is still an ideologically sensitive issue in China. As a consequence, there are trading bans on about two-thirds of the shares of listed state-owned enterprises to ensure
46、that these companies remain state-owned. In China, corporate financial data are not reliable (sometimes even fabricated), and the stock market is not transparent. Corporate bankruptcies are rare and standards of corporate governance are very low. With little knowledge of or limited experiences in st
47、ock investments, most individual investors/stockbrokers select stocks according to both past return performances of and current rumors on companies. This practice is commonly known7 as “stir-frying stocks.” Individual stock prices are therefore often pushed too high (or too low) and then are quickly
48、 corrected. The consequence of “stir-frying stocks” is a stock market mania where stock prices can be pushed up by several hundred times and quickly corrected later on. 7The rumor-based “stir-frying investment” by individual investors in China market suggests a pattern of return reversals. It also s
49、uggests a herding behavior that is unique in the sense that it is the herding among uninformed individual investors. Institutional investors herding behavior in emerging market is well documented. As a consequence, return continuation can be the norm in these markets. Whether the unique herding behavior leads to return continuation in the China stock market is an interesting empirical question. The main objectives of this paper are two-fold: (1) to see if return reversal or return continuation exists in China stock market and to test if contrarian and momentum strategies can generat
