How Does Economic Policy Uncertainty Affect Momentum Returns? Evidence from China

Abstract

Economic policy uncertainty has been identified as a new macroeconomic risk factor that harms the stock market’s profitability. This paper examines the impact of the Chinese EPU levels on one of the most famous financial anomalies—momentum returns. A new EPU index based on mainland China newspapers is used to obtain more accurate EPU–momentum relations. We selected 3958 Chinese listed companies’ stocks from 2011 to 2022 to establish time-series (TSM) and returns signal momentum strategies (RSM). Although the momentum effect in the Chinese stock market is weak, the EPU-based dynamic-threshold RSM strategies yield significant positive excess returns: eight times more excess returns than conventional fixed-threshold strategies. We used the ordinary least squares regression model (OLS), and the event study method only identified robust negative EPU–momentum relationships in the Chinese stock market during high-EPU stages. Surprisingly, the negative relationship between EPU and momentum returns turns positive during expansion cycles. We explain this phenomenon as follows: expansions increase Chinese investors’ confidence, and uncertainties reduce market manipulations.