Correlation-based investment strategies: A comparison between Chinese and US stock markets

Abstract

This paper studies the feasibility of correlation-based investment strategies in the Chinese and US stock markets. After testing eight different correlations between returns and various factors under two different stock selection methods, the highest correlation is identified between returns and volatility under the Pearson correlation coefficient, in which the volatility is defined as the ratio of the differences between the maximum and minimum prices within two successive trading days. The investment strategies are investigated under two stock selection methods and three portfolio construction methods, and SSCI and S&P500 Index are chosen as benchmarks respectively. In the Chinese stock market the contrarian strategy obtain significant positive excess returns while in the US stock market the momentum strategy perform better. The results show that correlation-based investment strategy is more feasible in the Chinese stock market than in the US, and the US stock market is more efficient than the Chinese stock market.