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

Ruanmin Cao (), Lajos Horvath, Zhenya Liu () and Yuqian Zhao ()
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Ruanmin Cao: CITIC Securities Co., Ltd.
Zhenya Liu: Renmin University of China
Yuqian Zhao: University of Waterloo

Review of Quantitative Finance and Accounting, 2020, vol. 54, issue 1, No 11, 335-358

Abstract: 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 .

Keywords: Momentum effect; Disposition effect; Functional principal component analysis; Portfolio selection; Chinese stock market (search for similar items in EconPapers)
JEL-codes: C58 G12 G15 G40 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (5)

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DOI: 10.1007/s11156-019-00791-x

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