The momentum premium under the influence of information uncertainty — evidence from the Chinese stock market

Abstract

From this study, we find that the momentum premia are universally positive and statistically significant across 16 different momentum trading strategies in the Chinese Class A share market. By defining the time periods following UP and DOWN market states according to prior 12 or 24-month average Chinese Class A share market returns, we show that the momentum premia of different momentum strategies over time periods following UP market state eclipse those found over time periods following DOWN market state in the Chinese Class A share market for the whole sample period from January 1996 to December 2008. Furthermore, by employing 7 different factors—firm size, firm age, analysts’ coverage, return volatility, dispersion in analysts’ earnings forecast, trading volume, the quality/strength of corporate governance (free float ratio)—to gauge the degree of firm-level information uncertainty, we evidence that the information uncertainty has an amplifying effect over the momentum premium, and the amplifying effect is more pronounced over time periods following DOWN market state. The results from the sub-period analysis revolving the inception of two Chinese financial market regulatory reforms—1) July 1st, 1999 the implementation of the new P.R.C. security law; 2) July 3rd, 2003 the opening of the Chinese Class A share market to qualified foreign institutional investors (QFII) dismiss the doubt that our findings could be sample time periodspecific. Compared with the tradition FF3F model, the Wang & Xu (2004)’s version of the FF3F model, with the value effect factor of the traditional FF3F model supplanted by residual free float ratio (proxy for the quality/strength of firm-specific corporate governance), exhibits more explanatory power over the momentum premia yet still fails to fully rationalize the momentum premia found in this study. This research fills the gap in the literature and expands the understanding of the momentum premium by offering empirical evidence of the dynamics of the momentum premia amid market swings, the impact of information uncertainty over momentum premia as well as the impact of information uncertainty over momentum premia amid market swings in the context of the Chinese stock market. The results from this study can potentially provide an important reference point for international and domestic investors in adjusting investment strategies and portfolio positions, or fishing for investment diversification opportunities in a financial market with volatile market condition such as the Chinese stock market.

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ORCID for Taufiq Choudhry: orcid.org/0000-0002-0463-0662

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