Contrarian Strategy And Cross-industry Momentum Strategy

More and more empirical works have shown the existence of return predictability in the stock market since 1980s.Among them are return reversal effect and momentum effect.Return reversal refers to the phenomenon that stock prices reverse itself;Momentum effect means that well-performed stocks keep doing better than others,vice versa.These phenomena contradict the efficient market hypothesis(EMH hereafter),and are therefore considered as market anomalies.According to the EMH,asset prices fully incorporate and reflect all available information.Prices always adjust to new information in a very short time.No investor can beat the market consistently since asset prices are unpredictable.The past information has no power on predicting the future gain.The only way that an investor can possibly obtain higher returns is by purchasing riskier investments.While the traditional efficient market theory cannot explain the market anomalies such as return reversal and momentum effects,behavior finance theory relaxes the rational participant hypothesis in the efficient market theory.Actually,there are many instances where emotion and psychology influence decisions,causing investors to behave in unpredictable or irrational ways.The theory explains reversal and momentum effects as the results from over-and-underreactions to market information.Investors are not necessarily rational;their investment decisions are affected by individual psychological factors.This phenomenon is pervasive among investors and cannot be offset,causing systematic bias.Due to certain bias,investment decisions may not satisfy utility maximization condition.Behavior finance theory seeks to combine behavioral and cognitive psychological theory with conventional economics and finance to provide explanations for why people make irrational financial decisions.The data used in this paper are selected from the China Stock Market Trading Database(CSMAR).This database records all stock trading information from 1990 to today,while the sample in our paper is from January 1,1997 to December 31,2016.We choose this particular sampling period for the following two reasons:First,stock markets in China does not impose the price limit policy until 1997.Stock prices before 1997 are highly volatile so that econometric analysis may not be reliable.Second,the number of listed companies is very small in the early stage.Finally,3238 stocks are selected in our sample.Our empirical work shows that the momentum effect does not exist in the Chinese stock market;short-term reversal effect is very significant,but medium and long-term reversal effect are not significant;the reversal effect in Shenzhen A-stock market is slightly stronger than that in Shanghai A-stock market;the reversal effect has been stronger in the recent years;compared with companies with large market capitalization,small-size companies tends to reverse more.We construct winner and loser portfolios as in Jegadeesh(1990)and find that the contrarian strategy generates an average 0.57%monthly abnormal return.In addition,we also examine the existence of the industry momentum effect in the Chinese stock market.Evidence shows that the industry momentum strategy generates significant positive returns in the bull market yet the magnitude is very small.This strategy may not be attractive if we take the transaction costs and the risk-free interest rate into consideration.