Trend Factor in China

Abstract

We propose a 4-factor model by adding an additional trend factor to Liu, Stambaugh and Yuan’s (2019; LSY-3) 3-factor model: market, size and value. Since individual investors contribute about 80% of the trading volume in China, the trend factor captures well the resulting important price and volume trends, and has a monthly Sharpe ratio of 0.48, much greater than those of the market (0.11), size (0.19) and value (0.28). The proposed 4-factor model explains all reported Chinese anomalies, including turnover and reversal that are unexplained previously by LSY-3. Moreover, the model explains well mutual fund returns, working as an analogue of Carhart (1997) 4-factor model in China. It also strongly outperforms the replication of Fama-French (2015) 5-factor model and Hou, Xue and Zhang (2015) q-factor model in terms of explanatory power.

Keywords: China Stocks, Trends, Predictability, Factor Model, Anomalies

JEL Classification: G12, G14, G15