A Research On The Mechanism Of The Turnover Effect In China's A-Share Market

Turnover is defined as the ratio of the trading volume to the total number of shares outstanding in a certain period.It is a standardized trading volume index,and is also one of the most important technical indicators in the stock market.The turnover directly reflects the activity of stock trading and the willingness of investors to trade.The high turnover of a stock indicates that the stock is favored by the market and investors have strong willingness to buy;on the contrary,the low turnover means the stock is ignored by the market.Turnover is endowed with liquidity,liquidity risk,heterogeneous beliefs,investor sentiment and other rich content in the related literatures.China's stock market is known for its high turnover level.According to statistics,the average monthly turnover of stocks in China's A shares markets reaches 52.2%during 1996 to 2017.That is,A-share stocks are,on average,completely changed hands every two months,which is much higher than that in mature stock markets.What exactly does the high turnover reflect in China's stock market?Liquidity,market irrationality or other content?This is the most fundamental problem in the stock market,but there is little literature available.The high turnover is not beneficial to the whole market or single stock.In terms of the market,the high turnover is usually accompanied by a sharp rise and fall in the market in the short term,which is not conducive to financial stability.For individual stocks,high turnover means predictable future losses,that is,the higher the turnover,the lower the expected returns.The negative cross-sectional relation between turnover and future returns is called turnover effect.As with other market anomalies,the mechanism of the turnover effect has always been the focus of scholars.The existing literature provides two main explanations for turnover effect according to the different understanding of turnover.On the one hand,traditional financial theory based on investor rationality and risk pricing argues that turnover is positively correlated with the liquidity.The high returns of low turnover stocks are due to the compensation for low liquidity or high liquidity risk.On the other hand,behavioral finance theory,which emphasizes investors' limited rationality and limits of arbitrage,believes that turnover reflects the disagreement among investors.Heterogeneous beliefs,together with short selling constraints,result in overvaluation of current stock prices,that is,price bubbles.In the subsequent period,the burst of the bubble leads to a fall in stock price.However,the relevant studies do not provide sufficient evidence for the two theories,which leads to the controversy about the interpretation of the turnover effect.Basing on the data of 2698 non-financial stocks which listed on China's Shanghai Stock Exchange and Shenzhen Stock Exchange from January 1995 to December 2017,this paper attempts to investigate the essence of turnover,the existence and the mechanism of the turnover effect in China's A-Share market.We first apply univariate portfolio sorting,bivariate portfolio sorting,panel regression and Fama-MacBeth regression to examine the turnover effect.Then,we construct proxies for liquidity,liquidity risk,heterogeneous belief,idiosyncratic risk to analyze the connotation of turnover.From the perspective of traditional finance and behavioral finance,we employ the liquidity premium theory,liquidity risk compensation theory,real options theory,and mispricing theory to analyze the mechanism of the turnover effect.The content and main conclusions of this article are as follows:Firstly,the results of portfolio-sorting tests and regression tests indicate that there is a significant turnover effect in China's A-share market.The stocks with low-turnover,on average,earn a 2.22%higher return per month than stocks with high-turnover.Further analysis shows that traditional factor pricing models such as CAPM and Fama-French three factor model and pricing factors such as size,liquidity,idiosyncratic volatility and systemic risk cannot fully explain this phenomenon.In addition,the low turnover return premium phenomenon is independent of the selection of sample interval,the January effect,the weighting method,and so on.However,it is closely related to the holding period.Specifically,the turnover effect only exists in weekly rebalanced portfolios and monthly rebalances portfolios.When the holding period is extended to one quarter or one year,it almost disappearsSecondly,we construct several alternative measures of liquidity from the perspective of price impact and spread,and find that turnover is positively correlated with liquidity.However,the proportion of turnover effect that can be explained by liquidity is relatively low,with an average of 13.2%.Therefore,we believe that the turnover effect does not have much to do with the liquidity premium.Thirdly,the turnover is in most cases positively,not negatively correlated with the liquidity risk.That is to say,the high-turnover stocks also have high liquidity risk,which is contrary to our intuition.The analysis of the relationship between liquidity risk and expected returns reveals that the liquidity risk in China's stock market has not been compensated accordingly.Empirical results show that the turnover effect cannot be explained from the perspective of liquidity risk compensationFourthly,we find that stock turnover is positively related to the firm-level idiosyncratic risk,and the turnover effect can be explained by the real-option theory.We measure the option-like feature by using market-to-book ratio,Tobin's Q,R&D investment,financing constraints and so on,and disclose that the turnover effect is more pronounced among stocks with abundant real options.We further extend the real-option theory based on the Two-Beta model of Campbell and Vuolteenaho(2004).The results show that the cash flow risk can significantly amplify the turnover effect of option-like stocksFifthly,the turnover effect can also be explained in the framework of behavioral finance,in which the low turnover return premium phenomenon is considered to be a mispricing and price delay correction caused by heterogeneous beliefs and limits of arbitrage.We construct multiple arbitrage risk measures such as analyst coverage,shareholder dispersion,and cash flow volatility from the perspective of fundamental risk,noise trader risk and implementation risk.The results of portfolio-sorting analysis and regression analysis show that the turnover effect significantly increases with the increase of the limits of arbitrage.When liquidity and heterogeneous beliefs are considered simultaneously,the proportion of turnover effect that can be explained by heterogeneous beliefs is up to 33.9%,which is much higher than that of liquidity.What's more,market sentiment and news sentiment is found to have a significant positive impact on the turnover effect.The results above indicate that heterogeneous beliefs are the main reason for the turnover effect,that is,the turnover effect is mainly attributed to mispricing rather than liquidity premiumAll in all,we find that the turnover effect in China's stock market is quite obvious.Monthly turnover is positively related to stock liquidity,liquidity risk,firm-level idiosyncratic risk and investors' heterogeneous beliefs.The turnover effect can be explained by real-option theory and mispricing theory.On the contrary,the liquidity premium theory is found to have relatively low explanatory power for the turnover effect,while the liquidity risk compensation theory has no explanatory power.Based on the conclusions of our study,we give policy recommendations from the following aspects:Firstly,regulators should strengthen investor education to enable investors to master basic financial knowledge and avoid blind investment.Investors should not simply equate high turnover with strong liquidity,but recognize that high turnover may indicate price bubbles and predictable losses.Secondly,relevant departments should optimize the market system by improving the margin trading system,introducing diversified financial derivatives such as stock options,developing institutional investors and securities analysts to reduce limits of arbitrage,which can improve market pricing efficiency.Thirdly,regulatory authorities should strengthen public opinion management and actively guide market sentiment.They should establish information disclosure platforms and timely disclosure the market information through media,network and other channels to correct over-optimistic or pessimistic market sentiment.They should regulate and supervise relevant news reports to ensure the true situation of firms is revealed objectively and accurately,and to prevent deliberate elevation or derogation of the company.Fourthly,the government should speed up the reform of capital market tax system,such as setting multi-stage rate according to the holding period,imposing high taxes on capital gains arising from ultra-short-term investment,and giving tax preferences to long-term investment,so as to guide investors to invest in value.