Empirical Research On Momentum Effect And Reversal Effect In China Stock Market

The discovery of momentum effect and reversal effect means that stock prices has a trend and can be predicted, which conflicts with the Efficient Market Hypothesis. As one of basics of the traditional finance the Efficient Market Hypothesis believes:investors are fully rational, transactions are randomly occurring and investors can arbitrage without risk infinitely. However it is hard to explain the momentum effect and the reversal effect by the Efficient Market Hypothesis. Behavioral finance combined with the psychology and other disciplines relaxes the assumptions of the Efficient Market Hypothesis. Human's bounded rationality, crowd behavior and incomplete market are three fundamental assumptions of Behavioral finance. Behavioral finance which successfully explained momentum effect and reversal effect think it was the result of human cognition and behavior bias in decision-making which makes investors made irrational behavior, so that the stock price appears short-term momentum and long-term reversal. Of course, such deviation caused by momentum effect can't last all the time, the rational investors will fix this error after excessive deviation and reversal effect make price return to the intrinsic value gradually. So this paper analyzes investors'cognitions and emotions and decision-making process, and then uses BSV model, DHS model and HS model to explain the momentum effect and reversal effect.In this paper, the empirical study examines all of China's A-shares in Shanghai and Shenzhen stock markets in May 1997-April 2010. The Chinese stock market empirical study result shows that the momentum effect and reversal effect in our country are complicated. In the short term, the winner portfolio has a momentum effect, but unexpectedly, the loser portfolio in the short term has a reversal effect instead of momentum effect and earn positive excess yield. Over the long term, the loser portfolio and zero cost investment portfolio appears strong reversal and consistent with the theoretical expectations and the findings of others, but the winner portfolio doesn't appears strong reversal.The empirical results can be explained from the following reasons:Stock turnover rate is very high in China's stock market; Most investors prefer speculating to investing; Disposition effect is serious and investors hold stocks which have losses for too long but sell stocks which have gains too early; There are many makers manipulation, insider stock trading; There are a large number of retail investors who generally overconfidence; The stock market is immature, and stock price always rises and falls quickly and sharply and deviate from intrinsic value too much; Without sell-short mechanism, China's stocks are always rise at the same time and fall at another same time. These conclusions will help us better understand China stock market and investors in China.