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Review of Quantitative Finance and Accounting

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29-01-2019 | Original Research

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

Authors: Ruanmin Cao, Lajos Horváth, Zhenya Liu, Yuqian Zhao

Published in: Review of Quantitative Finance and Accounting | Issue 1/2020

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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 .

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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.

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

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.

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.

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Title: A study of data-driven momentum and disposition effects in the Chinese stock market by functional data analysis
Authors: Ruanmin Cao
Lajos Horváth
Zhenya Liu
Yuqian Zhao
Publication date: 29-01-2019
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 1/2020
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-019-00791-x

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