Trend Factor in China

Abstract

We propose a 4-factor model for the Chinese stock market by adding a trend factor to Liu, Stambaugh, and Yuan’s (2019) 3-factor model, which consists of the market, size, and value. Ac-counting for the fact that individual investors contribute about 80% of the total trading volume, the trend factor captures salient relevant price and volume trends, and earns a monthly Sharpe ratio of 0.48 – much greater than that of the market (0.11), size (0.20), and value (0.28). Our 4-factor model explains all reported Chinese anomalies – including turnover and reversal – that are difficult to explain by existing models. Our model also outperforms strongly the replication of Fama and French’s (2015) 5-factor model and Hou, Xue, and Zhang’s (2015) 4-factor model in terms of both the Sharpe ratio and explanatory power. Moreover, our model can also explain mutual fund returns, working as an analogue of Carhart’s (1997) 4-factor model in China.

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

JEL Classification: G12, G14, G15