Wax and wane of the cross-sectional momentum and contrarian effects: Evidence from the Chinese stock markets

• Published in: Physica A 2017-11, Vol.486, p.397-407
• Main Authors: Shi, Huai-Long, Zhou, Wei-Xing
• Format: Article
• Language: English
• Subjects: Adaptive market hypothesis; Contrarian effect; Econophysics; Momentum effect
• ISSN: 0378-4371; 1873-2119
• DOI: 10.1016/j.physa.2017.05.078

This paper investigates the time-varying risk-premium relation of the Chinese stock markets within the framework of cross-sectional momentum and contrarian effects by adopting the Capital Asset Pricing Model and the Fama–French three-factor model. The evolving arbitrage opportunities are also studied by quantifying the performance of time-varying cross-sectional momentum and contrarian effects in the Chinese stock markets. The relation between the contrarian profitability and market condition factors that could characterize the investment context is also investigated. The results reveal that the risk-premium relation varies over time, and the arbitrage opportunities based on the contrarian portfolios wax and wane over time. The performance of contrarian portfolios are highly dependent on several market conditions. The periods with upward trend of market state, higher market volatility and liquidity, lower macroeconomics uncertainty are related to higher contrarian profitability. These findings are consistent with the Adaptive Markets Hypothesis and have practical implications for market participants. •We test the Adaptive Markets Hypothesis in the Chinese stock markets.•The return predictability and the risk-premium relation vary over time.•The trading strategies based on contrarian portfolios wax and wane over time and are dependent on market conditions.•Our findings support the Adaptive Markets Hypothesis.