Momentum effects on the Chinese stock market

Abstract

Momentum effect refers to a pattern in stock price behaviour whereby prices of stocks which experienced relatively strongest gains in the past (“winners”) continue to overperform, and those of stocks with relatively weakest gains in the past (“losers”) continue to underperform. Momentum profits are widely documented in most developed markets except for Japan. However, evidence on their existence is ambiguous in developing markets, especially in China. This thesis attempts to provide an insight into the existence and characteristics of momentum effects in China, and to reconcile what often appears to be contradicting results in the literature. In this thesis, momentum strategies in Chinese A-share stock markets (1991-2012) are evaluated. Overall, no momentum profits but significant contrarian profits are found for whole sample periods. It is found that the ambiguous results with respect to momentum effects in Chinese stock market are due to different sample periods examined. This finding helps to reconcile often-contradicting results as reported by other studies. The second part of this thesis investigates the reason as to why no momentum profits are found in the Chinese stock market by examining momentum returns in different marketstates. It is found that in the Chinese stock market, momentum strategies generate relatively less momentum returns following UP market-states than following DOWN market-states. Motivated by this result, momentum strategies following different market dynamics are studied subsequently in part three. The results reveal that momentum effects are more pronounced when markets stay in the same state than when they transition into a different state. This finding is accordant with the theory of overreaction. This finding further suggests that the Chinese stock market is not fundamentally different from other, developed markets. The lack of absolute momentum in the Chinese stock market is not due to investors’ rationality but rather to the unique features of that market.