Contrarian Strategy And Its Application In China's Security Market

In recent years, there has been increasing popularity among the study on predictability of capital market. A number of research present evidence that capital market is to some extent predictable. And the predictability stands out to be that security return takes on positively auto-correlated in short term while negatively auto-correlated in long term. Based on long-horizon negative auto-correlation, the contrarian investment strategy that buys previous losers and sells previous winners can be derived. The contrarian strategy is testified to yield significant profits.China's security market is a newly-established and immature market. Is contrarian strategy also effective in such a market? And if it is, what is the underlying reason ?With the title of "contrarian strategy and its application in China's security market", this paper has two objectives. The first is to survey the related theory of contrarian strategy and the second is to study the application of contrarian strategy in China. Therefore, the structure of this paper is arranged as follows:Part of introduction expounds the working background and working clue as well as some problems interrelated.Chapter I is titled "survey of contrarian theory" which reviews main literature as to contrarian theory abroad. This chapter first draws out contrarian strategy with the discussion of predictability of capital market. And then it puts the emphasis on the economic explanation to the capability of contrarian strategy to get excess return. The economic explanation is spread in traditional framework and financial framework respectively. The traditional framework is consisted of EMH, CAPM and the three-factor model of Fama-French. And the behavioral framework is set forth from the mechanism of under-reaction and overreaction.Chapter II is titled "On the application of contrarian strategy in China's security market". This chapter first states that contrarian strategy is effective in China's security market by way of empirical analysis and then gives the underlying reason such as reversion of policy, reversion of funds and overreaction of investors to earnings.Besides, the characteristic of short circulation and high profitability is discussed.Chapter III is titled "Theoretical analysis on sources of contrarian profits and empirical analysis on China's security market". Usually, the contrarian profits are decomposed into two parts: one is induced by over-reaction and the other is induced by delayed reaction to common factors. In this chapter, we construct a return-generating model which is applicable to China's security market and also decompose contrarian profits in China into two parts: one is induced by over-reaction and the other is induced by negative auto-correlation of common factor in time series. Empirical analysis states that overreaction contributes to the profits for the most part. The paper quantifies common factor with the index return. Also, the paper gives the reason why common factor takes on negative auto-correlated.The end is the part of conclusion and prospect. Based on the actuality and possible tendency of China's security market , the paper discusses the prospect of contrarian strategy in China. The paper argues that contrarian strategy also is profitable in the future while its cycle will increase moderately and the contribution of overreaction to profits will rise.