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

  • Ruanmin Cao
  • Lajos Horváth
  • Zhenya LiuEmail author
  • Yuqian Zhao
Original Research
  • 20 Downloads

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 

JEL Classification

C58 G12 G15 G40 

Notes

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Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  • Ruanmin Cao
    • 1
  • Lajos Horváth
    • 2
  • Zhenya Liu
    • 3
    • 4
    Email author
  • Yuqian Zhao
    • 5
  1. 1.CITIC Securities Co., Ltd.BeijingChina
  2. 2.Department of MathematicsUniversity of UtahSalt Lake CityUSA
  3. 3.School of FinanceRenmin University of ChinaBeijingChina
  4. 4.CERGAMAix-Marseille UniversityAix-en-ProvenceFrance
  5. 5.Department of Statistics and Actuarial ScienceUniversity of WaterlooWaterlooCanada

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