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Profitability of reversal strategies: A modified version of the Carhart model in China

Author

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  • Zhang, Wei
  • Wang, Guanying
  • Wang, Xingchun
  • Xiong, Xiong
  • Lei, Xuan

Abstract

This paper shows that buying stocks that have performed poorly and selling stocks that have performed well in the past generates positive returns in the Chinese stock market. Profits from reversal strategies cannot be explained by systematic risk and fundamental factors. Testing the Fama-French three-factor model and reversal strategies in multiple formation periods, we find that the price-to-earnings ratio explains the stock returns better than book-to-market ratio does, and investors benefit more from short-term reversal strategies than medium-term momentum strategies. Substituting the book-to-market factor and momentum factor for the price-to-earnings ratio factor and reversal factor, we propose a modified Carhart model. Our findings deepen understanding on the link between Chinese stock returns and their historical performance.

Suggested Citation

  • Zhang, Wei & Wang, Guanying & Wang, Xingchun & Xiong, Xiong & Lei, Xuan, 2018. "Profitability of reversal strategies: A modified version of the Carhart model in China," Economic Modelling, Elsevier, vol. 69(C), pages 26-37.
    • Handle: RePEc:eee:ecmode:v:69:y:2018:i:c:p:26-37
    DOI: 10.1016/j.econmod.2017.09.003
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    3. Lin, Hung-Wen & Huang, Jing-Bo & Lin, Kun-Ben & Zhang, Joyce & Chen, Shu-Heng, 2020. "Which is the better fourth factor in China? Reversal or turnover?," Pacific-Basin Finance Journal, Elsevier, vol. 62(C).
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    8. Wen, Danyan & Wang, Yudong & Zhang, Yaojie, 2021. "Intraday return predictability in China’s crude oil futures market: New evidence from a unique trading mechanism," Economic Modelling, Elsevier, vol. 96(C), pages 209-219.
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    More about this item

    Keywords

    Reversal effect; Asset pricing; CAPM; Fama-French model; Carhart four-factor model;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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