Why the Dogs of the Dow Bark Loudly in China

Abstract

The Dogs of the Dow (Dow Dogs) strategy, which has gained widespread popularity in the U.S., is found to be considerably successful in China’s stock markets. This trading strategy contradicts the well-established efficient market hypothesis. This study examines the cross-sectional variations in the magnitude of the predictive power of the Dow Dogs strategy using Chinese stocks for 1994-2009. Our results suggest that (1) Significant Dow Dogs effect apply to Class A shares, but not Class B shares; (2) Stocks priced between $1 and $5 demonstrate the strongest Dogs effect among all stock price ranges; (3) Changes in share price range has the most powerful impact on risk adjusted return, followed by changes in the AB share class, re-balancing frequency and number of Dogs in the portfolio. Our results suggest that the superior predictive power of the Dow Dogs strategy is mainly driven by behavioral factors. Our overall findings support the behavioral hypothesis in which market inefficiency stems from investors irrationality and herding behaviors. This study provides practical implications to both government regulators and finance practitioners.

Keywords: Dogs of the Dow, China stock market, market efficiency, Dow Jones Industrial Average (DJIA), capital markets, foreign investors, herding behaviors, market economy, Shenzhen Stock Exchange (SZSE), State-Owned Enterprises (SOEs)

JEL Classification: G14, G15