Abstract
We show that the estimated shell value of reverse mergers dramatically drops in the out-of-sample periods of Liu et al. (2019, Journal of Financial Economics), which is related to Chinese IPO policy change and system reforms. This structural break is due to the fact that fewer firms choose to go public through a reverse merger. Thus, we document that the shell contamination is considerably mitigated and reconstruct factor models by flexibly eliminating the smallest 30% of stocks. Compared with other popular factor models in the finance literature, our revised CH3/4 model not only has the smallest model specification errors but also helps effectively explain the 25 Fama–French portfolios and most of reported stock anomalies in China.
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