Price Manipulation and Industry Momentum: Evidence from the Chinese Stock Market

Abstract

Recent theoretical studies (Aggarwal and Wu, 2006; Mei, Wu and Zhou, 2004) show that trade-based stock price manipulation is a possible source of the momentum effect. This paper proposes three sets of testable hypotheses and provides empirical evidence for a manipulation-based explanation of momentum. Using weekly data on 14 CITIC industries in the Shanghai A-share market from 1997 to 2006, our analysis of industry momentum shows that cumulative returns first increase then decrease across holding periods, and the returns monotonically decrease across formation periods. This return pattern is consistent with a so-called "pump and dump" scheme, where momentum is created by manipulators and chased by speculators. We attribute the source of momentum to the positive own-autocorrelation, which dominates the cross-autocorrelation effect of industry returns. We also find that momentum profits are higher in the bull than in bear market, and most of the profits come from the gains of winning industries rather than the losses of losing industries. These empirical results, when related to some well-documented behavioral biases of Chinese speculators, tell us a possible stock-market manipulation story of momentum.

Keywords: Price manipulation, Momentum, Industry momemtum, Behavioral biases, Chinese Stock Market

JEL Classification: G12, G15, P34