This paper evaluates the profitability of momentum strategies before and after the Non-tradable Share Reform in the Chinese Stock Market. The reform started from May 2005 and ended in December 2007. It aims to improve the liquidity and transparency of the Chinese stock market by decreasing the weight of non-tradable stock shares, and increasing the weight of tradable stock shares issued by listed companies. My objective is to observe whether momentum effect or reversal effect exist during these two time periods, considering the fact that momentum and reversal effects have a tight relationship with market efficiency. I apply the J Months/ K Months strategy (also known as momentum strategy) suggested by Jegadeesh and Titman (1993) in my study, where I form a winner’s portfolio and loser’s portfolio based on their returns in the past 6 months, then I hold these two portfolios for both 6 and 12 months to generate the winner-loser returns. My results show that before the Non-tradable Share Reform, positive profits can be generated by applying the momentum strategies. However, after the Non-tradable Share Reform, momentum effect is replaced by a significant reversal effect. These results probably can be explained by the behavioral models. According to behavioral literature, investors tend to be either underreact or overreact when dealing with stock tradings. To be specific, in this study, before the Non-tradable Share Reform, the trading environment is so inefficient that investors tend to become irrational when making a investment decision, which leads to the momentum profits. After the Non-tradable Share Reform, however, the equity market is becoming more efficient that stock prices turn back to their fair values, and as a result, the returns are reversed eventually.
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An Empirical Study of The Profitability of Momentum Strategies In The Chinese Stock Market
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