Abstract
This investigation studies the impact of mutual fund herding on the returns achieved by contrarian strategy from 1990 to 2015 in the Chinese stock market. The relationship between the profit gained by the contrarian strategy and the macroeconomic environment is also examined. First, the returns of the contrarian strategy in China’s stock market are found to be significant. Second, most loser stocks with a high degree of mutual fund herding outperform loser stocks with a low degree of mutual fund herding, revealing that the profitability of an investment portfolio depends on the degree of mutual fund herding. Third, investors should buy loser stocks with a high degree of herding and sell winner stocks with a low degree of herding during a two-year formation period, over which zero-cost contrarian strategies yield the significantly highest return. Finally, the payoff of contrarian strategies is positively related to the herding effect and negatively related to macroeconomic variables.
Highlights
Investment strategies, which can be grouped into contrarian and momentum strategies, have been the topic of many financial studies
This study considers the effect of herding behavior on the returns of contrarian strategies and zero-cost portfolios that are based on asymmetry between herding behavior and the returns of investment portfolios
This investigation finds that a contrarian strategy that involves buying a loser stock portfolio and selling a winner stock portfolio is effective in the Chinese stock market
Summary
Investment strategies, which can be grouped into contrarian and momentum strategies, have been the topic of many financial studies. The literature presents contradictory findings about the validity of contrarian and momentum strategies in the Chinese stock market. To elucidate the economic value of the asymmetric relationship between herding and an investment strategy, this investigation examines the profitability of a zero-cost portfolio which is based on various degrees of herding and a contrarian strategy. It uses an intuitive herding measure that was proposed by Lakonishok et al (1992) and individual stock data to elucidate the effect of investment strategies in the Chinese stock market. This investigation considers the asymmetric relationship between herding behavior and investment portfolios to construct zero-cost portfolios.
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