| dc.description.abstract | A generation ago. the intellectual dominance of the efficient markets hypothesis as the accepted asset pricing paradigm was unchallenged. It was generally believed that securities markets were extremely so efficient that prices in capital markets reflected the "true" intrinsic values of the underlying assets, commensurate with their risk. By the start of the twenty-first century, however, the acceptance of the efficient market hypothesis had become far less universal. Mounting anomalous evidence evoked a multidisciplinary
approach to asset pricing incorporating, among others, psychological and behavioural theories. The main thrust of the new proposition was that asset prices had elements of mis-valuation that could be profitably exploited by a properly designed trading strategy. Many financial economists, researchers and statisticians have joined in the enterprise seeking to vindicate the hypothesis that stock prices in capital markets are, at least partially, predictable.
This thesis uses data from the NSE to test whether past-price momentum based trading strategies could generate significant profits. Further, consistent with prior literature that has sought to link momentum profits to various firm and market characteristics, this study inquired into the role of size, market wide risk, transaction costs, and trading volume in momentum profitability, and in addition, whether the phenomenon was permanent or transient, had a calendar regularity or otherwise, and whether it was behavioural or risk based.
The study used monthly stock returns for all shares traded at the NSE from 1995 to 2007, inclusive. The strategies considered chose stocks and formed overlapping winner and loser portfolios on the basis of the returns over the past 3, 6, 9. and 12 months. For each of these formation periods, we also consider holding periods of 3. 6, 9. and 12 months. These combined to give a total of 16 strategies. To investigate the existence of price momentum, we tested whether past winners continued to outperform past losers.
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In addition, factor-mimicking portfolios were formed and tested for evidence the profitability was a result of size, trading volume and risk. We then formed and followed portfolios for up to 60 months to check for any reversal and calendar regularity. Finally the momentum profits were decomposed and tested to ascertain whether it was a time- series or cross-sectional phenomenon.
The results of the initial unrestricted tests revealed the existence of significant momentum, which could be the basis of profitable investment strategies. An analysis ol factor-mimicking portfolios revealed the absence of a discernible size effect, that momentum profitability is a feature restricted to only those stocks that experience low to medium activity, and is absent in high volume stocks, and that market risk could not adequately explain the profits. It was also found that the incorporation of transaction costs in our strategies could significantly dissipate the profits, that there was April calendar regularity to the profits, and that there was mild reversal of profitability in the medium term. Finally, we concluded that momentum is a time-series rather than a cross- sectional phenomenon.
Through this research, we found that unlike the neo-classical finance theory suggests, individual investors do not always make rational investment decisions. Their investment decision-making is influenced, to a great extent, by behavioural factors. These behavioural factors must be taken into account while making investment decisions. Investment advisors and finance professionals must incorporate behavioural issues as risk factors in order to formulate effective investment strategies for individual investors
The findings of this study are to be accepted and evaluated in the context of the following limitations and qualifications. First, is the fact that the methods and approaches used are just a selection among the diverse set (skip v non-skip, overlapping v non-overlapping, value weight v equal eight, decile v quintile). Secondly, because of the small listing at the NSE, we included in our sample low priced or low market capitalization stocks, which could have contributed to decreased significance. Thirdly, the incidence of momentum could be sample period specific, with some periods
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exhibiting the phenomenon to a higher degree than others. Fourthly, there were gaps in data that necessitated a degree of subjectivity or a restriction of the extent of testing. Lastly, structural inefficiencies, lack of automation, thin trading and weak legal and administrative institutions could make comparisons of results tenuous.
We suggest that researchers could test the robustness of the results by using alternatives methods, revisit the controversial results by using out of sample data, use strategies with different formation/holding period combinations, and test inter market regional strategies that include NSE. | en |
