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Momentum Or Reversal Based On Residual Returns

Posted on:2013-03-16Degree:MasterType:Thesis
Country:ChinaCandidate:X NingFull Text:PDF
GTID:2249330395982025Subject:Financial engineering
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The Efficient Market Hypothesis plays an important role in the theory of financial markets. The Efficient Market Hypothesis is an important cornerstone of modern financial theory. It considers that market can make a rapid and accurate response to information, not regular reaction or overreaction. Even if there is, it is random. So stock price can not be predicted, and technical analysis can not obtain excess returns. But Jegadeesh and Titman (1993,2001) confirmed momentum in stock market, namely, stock price continues the original direction of movement. De Bondt and Thaler (1985) confirmed reversal in stock market, namely, stock price reverses the original direction of movement.After that, in the last few decades, a number of scholars undertook extensive and thorough discussion. Such as, momentum and reversal existence, performance characteristics, source of returns, risk pricing explanation, behavioral finance explanation and transaction costs and so on. In these studies, portfolio strategies are calculated based on the total returns. With further research, some scholars have found that there are some shortcomings of momentum and reversal strategies based on total returns. Because the portfolio can not reflect the relative strength of stock returns effectively, and momentum or reversal portfolio based on total returns are. comprised of stocks that can be characterized as high beta, small cap. Therefore they are taken bigger risk.As a consequence, by using the risk adjusted returns evaluation, this paper studies momentum or reversal based on residual returns in China’s A-share stock market by using monthly stock returns. In each month of the sample, the average monthly returns and the average Fama and French three-factor are calculated for each stock in the past J months. Residual returns are estimated each month for all eligible stocks using the Fama and French three-factor model. Holding period returns are sorted by standardized residual returns in descending order. Arbitrage portfolio is constructed by using the same way as in Jegadeesh and Titman (1993, 2001), and is calculated monthly returns in the K months as well as the winner and loser portfolio. The reason why the holding period returns are sorted by standardized residual returns is that the residual returns which is eliminated the exposure to Fama and French three-factor can truly reflect the company-specific level of stock returns. It can reflect the relative strength of stock earnings effectively. It can also be more conductive to obtain and study momentum and reversal.This paper makes comparisons from different angles. Such as, results analysis and the empirical test of the total returns momentum and reversal strategies and residual momentum and reversal strategies, residual momentum and reversal before and after the non-tradable shares reform and residual momentum or reversal of stock with different features. The paper found that:First, China’s A-share market has residual reversal and no residual momentum. Residual reversal strategy is more effective than the total returns reversal strategy to reflect the reversal. Second, volatility of the residual reversal strategy returns is smaller than the total returns reversal strategy. When undertaking the same risks, residual reversal will produce greater benefits. Third, residual reversal portfolio has lower systemic risk. It is less affected by firm size. Fourth, the residual reversal is more obvious and intense after the non-tradable shares reform. And the returns of portfolio are far more than the empirical results of the full sample. Fifth, residual reversal is larger and more significant in growth stocks, small-cap stocks, low-priced stocks and low turnover stocks, relative to value stocks, large-cap stocks, high-priced stocks and high-turnover stocks. In addition, high turnover stocks show residual momentum.The innovation of this paper is:First, it’s the first try to study momentum or reversal strategies in China’s A-share market. Different from significant momentum in monthly returns in U.S. stock market, most studies show that China’s A-share market has no evidence of momentum, has evidence of reversal in the monthly returns, therefore the study emphasizes on the residual reversal strategy; Second, the paper not only analyzes the total returns momentum or reversal strategy but also compares and analyzes the residual momentum or reversal strategy; Third, the paper discusses the residual momentum or reversal strategy characteristics from different angles of view:momentum or reversal portfolio returns, volatility of risk-adjusted portfolio returns, portfolio Sharpe ratio and risk exposure to Fama and French three-factor; Fourth, the paper studies the residual momentum or reversal strategies before and after the non-tradable shares reform; Fifth, the paper studies the residual momentum or reversal portfolio returns performance in stocks of different characteristics.
Keywords/Search Tags:Residual momentum strategy, Residual reversal strategy, Totalreturns momentum strategy, Total returns reversal strategy, Fama and Frenchthree-factor Model
PDF Full Text Request
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