Skip to main content
SpringerLink
Log in

A study of data-driven momentum and disposition effects in the Chinese stock market by functional data analysis

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

We apply a functional data analysis approach to decompose the cross-sectional Fama–French three-factor model residuals in the Chinese stock market. Our results indicate that other than Fama–French three factors, there are two orthonormal asset pricing factors describing the behavioral biases in their historical performances: between winner and loser stocks, and extreme and mediocre-performing stocks, respectively. We explain these two factors through investors’ overreaction, overconfidence and the lead-lag effect. These findings empirically show the existence of momentum and disposition effects in the Chinese stock market. A buy-and-hold mean-variance optimized portfolio incorporating these two market anomalies boosts the Sharpe ratio to 1.27 .

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2
Fig. 3
Fig. 4
Fig. 5
Fig. 6

Similar content being viewed by others

Notes

  1. In this paper, we term the China A-shares market as the Chinese stock market, which is dominated in Chinese Yuan/CNY, and is mainly accessible for local investors. Compared with the developed markets, individual investors in this market outweigh institutions regarding the stock capitalization held.

  2. The closing price is adjusted by its stock splits and dividend payments.

  3. There are non-tradable shares in the Chinese stock market before 2005 because of the liquidity shortage. In order to reconstruct the ownership structure of listed companies, the authority launched a structural reform to eliminate the non-tradable shares during 2005–2006.

  4. We also applied the same approach to the U.S. market including more than 7000 shares in the NYSE, AMEX and NASDAQ from 2000 to 2017. The result showed that the \(FPC2_t\) factor still exists but is not as strong as in the Chinese stock market.

References

  • An L (2015) Asset pricing when traders sell extreme winners and losers. Rev Financ Stud 29:823–861

    Google Scholar 

  • Asness CS, Moskowitz TJ, Pedersen LH (2013) Value and momentum everywhere. J Finance 68:929–985

    Google Scholar 

  • Barberis N, Shleifer A, Vishny R (1998) A model of investor sentiment. J Financ Econ 49:307–343

    Google Scholar 

  • Barberis N, Xiong W (2009) What drives the disposition effect? An analysis of a long-standing preference-based explanation. J Finance 64:751–784

    Google Scholar 

  • Ben-David I, Hirshleifer D (2012) Are investors really reluctant to realize their losses? Trading responses to past returns and the disposition effect. Rev Financ Stud 25:2485–2532

    Google Scholar 

  • Birru J (2015) Confusion of confusions: a test of the disposition effect and momentum. Rev Financ Stud 28:1849–1873

    Google Scholar 

  • Blitz DC, Van Vliet P (2007) The volatility effect. J Portf Manag 34:102–113

    Google Scholar 

  • Blitz DC, Huij J, Martens M (2011) Residual momentum. J Empir Finance 18:506–521

    Google Scholar 

  • Bondt WFM, Thaler R (1985) Does the stock market overreact? J Finance 40:793–805

    Google Scholar 

  • Cakici N, Chan K, Topyan K (2017) Cross-sectional stock return predictability in China. Eur J Finance 23(7–9):581–605

    Google Scholar 

  • Carhart MM (1997) On persistence in mutual fund performance. J Finance 52:57–82

    Google Scholar 

  • Chan LKC, Jegadeesh N, Lakonishok J (1995) Evaluating the performance of value versus glamour stocks the impact of selection bias. J Financ Econ 38:269–296

    Google Scholar 

  • Chan SH, Kim KA, Rhee SG (2005) Price limit performance: evidence from transactions data and the limit order book. J Empir Finance 12:269–290

    Google Scholar 

  • Chen G, Kim KA, Nofsinger JR, Rui OM (2007) Trading performance, disposition effect, overconfidence, representativeness bias, and experience of emerging market investors. J Behav Decis Mak 20:425–451

    Google Scholar 

  • Cheema MA, Nartea GV (2014) Momentum returns and information uncertainty: evidence from China. Pac Basin Finance J 30:173–188

    Google Scholar 

  • Cooper MJ, Gutierrez RC, Hameed A (2004) Market states and momentum. J Finance 59:1345–1365

    Google Scholar 

  • Daniel K, Titman S (1997) Evidence on the characteristics of cross sectional variation in stock returns. J Finance 52:1–33

    Google Scholar 

  • Egginton J, Hur J, Singh V (2018) The impact of elasticity on disposition effect driven momentum, substitutability, size, and January seasonality. Rev Quant Finan Acc. https://doi.org/10.1007/s11156-018-0725-6

    Article  Google Scholar 

  • Fama EF, MacBeth JD (1973) Risk, return, and equilibrium: empirical tests. J Polit Econ 81:607–636

    Google Scholar 

  • Fama EF, French KR (1992) The cross-section of expected stock returns. J Finance 47:427–465

    Google Scholar 

  • Fama EF, French KR (1993) Common risk factors in the returns on stocks and bonds. J Financ Econ 33:3–56

    Google Scholar 

  • Fama EF, French KR (2012) Size, value, and momentum in international stock returns. J Financ Econ 105:457–472

    Google Scholar 

  • Fama EF, French KR (2015) A five-factor asset pricing model. J Financ Econ 116:1–22

    Google Scholar 

  • Frazzini A (2006) The disposition effect and underreaction to news. J Finance 61:2017–2046

    Google Scholar 

  • Frazzini A, Pedersen LH (2014) Betting against beta. J Financ Econ 111:1–25

    Google Scholar 

  • Gandhi P, Lustig H (2015) Size anomalies in us bank stock returns. J Finance 70:733–768

    Google Scholar 

  • Gibbons MR, Ross SA, Shanken J (1989) A test of the efficiency of a given portfolio. Econometrica J Econom Soc 57(5):1121–1152

    Google Scholar 

  • Griffin JM, Ji X, Martin JS (2003) Momentum investing and business cycle risk: evidence from pole to pole. J Finance 58:2515–2547

    Google Scholar 

  • Grinblatt M, Han B (2005) Prospect theory, mental accounting, and momentum. J Financ Econ 78:311–339

    Google Scholar 

  • Hall P, Hosseini-Nasab M (2006) On properties of functional principal components analysis. J R Stat Soc Ser B 68:109–126

    Google Scholar 

  • Hörmann S, Kokoszka P (2010) Weakly dependent functional data. Ann Stat 38:1845–1884

    Google Scholar 

  • Horváth L, Kokoszka P (2012) Inference for functional data with applications. Springer, Berlin

    Google Scholar 

  • Hur J, Singh V (2016) Reexamining momentum profits: underreaction or overreaction to firm-specific information? Rev Quant Finan Acc 46:261–289

    Google Scholar 

  • Jegadeesh N, Titman S (1993) Returns to buying winners and selling losers: implications for stock market efficiency. J Finance 48:65–91

    Google Scholar 

  • Jegadeesh N, Titman S (2001) Profitability of momentum strategies: an evaluation of alternative explanations. J Finance 56:699–720

    Google Scholar 

  • Kang J, Liu M, Ni SX (2002) Contrarian and momentum strategies in the China stock market: 1993–2000. Pac Basin Finance J 10:243–265

    Google Scholar 

  • Kokoszka P, Miao H, Reimherr M, Taoufik B (2018) Dynamic functional regression with application to the cross-section of returns. J Financ Econom 16:461–485

    Google Scholar 

  • Li CA, Yeh CC (2011) Investor psychological and behavioral bias: do high sentiment and momentum exist in the china stock market? Rev Pac Basin Financ Mark Pol 14:429–448

    Google Scholar 

  • Lo AW, MacKinlay AC (1990) When are contrarian profits due to stock market overreaction? Rev Financ Stud 3:175–205

    Google Scholar 

  • Ni ZX, Wang DZ, Xue WJ (2015) Investor sentiment and its nonlinear effect on stock returns: new evidence from the Chinese stock market based on panel quantile regression model. Econ Model 50:266–274

    Google Scholar 

  • Ramsay JO, Silverman BW (2006) Functional data analysis. Wiley Online Library

  • Shefrin H, Statman M (1985) The disposition to sell winners too early and ride losers too long: theory and evidence. J Finance 40:777–790

    Google Scholar 

  • Shen Z, Coakley J, Instefjord N (2014) Earnings management and IPO anomalies in China. Rev Quant Finance Acc 42:69–93

    Google Scholar 

  • Tan L, Chiang T, Mason JR, Nelling E (2008) Herding behavior in Chinese stock markets: an examination of A and B shares. Pac Basin Finance J 16:61–77

    Google Scholar 

  • Wong KA, Tan RSK, Liu W (2006) The cross-section of stock returns on the shanghai stock exchange. Rev Quant Finance Acc 26:23–39

    Google Scholar 

  • Wu Y (2011) Momentum trading, mean reversal and overreaction in Chinese stock market. Rev Quant Finance Acc 37:301–323

    Google Scholar 

  • Zheng X (2015) Initiation of trades on the Chinese stock market. Rev Pac Basin Financ Mark Pol 18:1550012

    Google Scholar 

  • Zhou ZG (2010) The high-volume return premium: evidence from the Chinese stock market. Rev Quant Finance Acc 35:295–313

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. CITIC Securities Co., Ltd., Beijing, 100016, China

    Ruanmin Cao

  2. Department of Mathematics, University of Utah, 155 1400 E, Salt Lake City, USA

    Lajos Horváth

  3. School of Finance, Renmin University of China, Beijing, 100872, China

    Zhenya Liu

  4. CERGAM, Aix-Marseille University, 13090, Aix-en-Provence, France

    Zhenya Liu

  5. Department of Statistics and Actuarial Science, University of Waterloo, Waterloo, N2L 3G1, Canada

    Yuqian Zhao

Authors
  1. Ruanmin Cao
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Lajos Horváth
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Zhenya Liu
    View author publications

    You can also search for this author in PubMed Google Scholar

  4. Yuqian Zhao
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Zhenya Liu.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Cao, R., Horváth, L., Liu, Z. et al. A study of data-driven momentum and disposition effects in the Chinese stock market by functional data analysis. Rev Quant Finan Acc 54, 335–358 (2020). https://doi.org/10.1007/s11156-019-00791-x

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-019-00791-x

Keywords

JEL Classification

Search

Navigation