Momentum, Acceleration and Non-Linearities in Equity Valuation on the Shanghai Stock Exchange

<p>The standard empirical paradigm for assessing the relationship between the market value of a firm’s equity and the accounting information appearing in the firm’s financial statements, is based on the assumption that the firm is indefinitely constrained to operate within its existing investment opportunity set. Based on this assumption, the Ohlson (1995) model, which is developed by characterising a firm’s investment opportunity set in terms of a first order vector system of stochastic differential equations, shows that the market value of a firm’s equity will be a linear combination of its current abnormal earnings, the current value of an “information” variable and the current book value of its equity. However, the pre-existing empirical evidence shows that the Ohlson (1995) model does not provide a satisfactory description of the relationship between the market value of a firm’s equity and the information appearing in its published financial statements. Recent developments in equity valuation theory also show that the higher order derivatives of the accounting variables comprising a firm’s investment opportunity set - that is, the momentum and acceleration of the accounting information disclosed in a firm’s financial statements - can potentially make a significant contribution to the overall market value of equity. This in turn will mean that a firm’s investment opportunity set ought to be characterised in terms of a second or third order system of stochastic differential equations. Omitting the momentum and acceleration of the accounting variables from the equity valuation process could lead to the under-estimation of equity values. Moreover, recent empirical evidence also shows that the market value of a firm’s equity is potentially, a complex non-linear function of a firm’s accounting information appearing in financial statements. The non-linear effects arise out of the adaptation (real) options associated with a firm’s ability to modify or even abandon its existing investment opportunity set. However, empirical work on the relationship between the market value of equity and the accounting information appearing in financial statements continues to be based on linear models which do not take account of either the momentum and acceleration in a firm’s accounting variables or the non-linear effects associated with the real options available to the firm. Given this, it is all but inevitable that when these valuation effects are ignored, systematic biases will arise in empirical work dealing with the determinants of equity values. Moreover, empirical work in this area has been almost exclusively based on North American and European data. There is, in particular, a dearth of empirical work in developing countries like the People’s Republic of China. This dissertation refines the equity valuation models summarised in the literature by incorporating momentum, acceleration and non-linear equity valuation effects and then empirically tests them against data obtained from the Shanghai Stock Exchange (SSE). The empirical analysis summarised in this dissertation shows that neither earnings momentum nor earnings acceleration exhibit a significant impact on the market value of equity for the pooled sample data on which the empirical analysis is based. However, when the pooled sample data are divided into three equally numerous groups based on each firm’s operational efficiency, earnings momentum for firms with moderate operational efficiency exhibits a significant association with the market value of equity. This contrasts with the low-efficiency and high-efficiency sub-sample firms, where earnings momentum appears to have an imperceptible effect on equity prices. However, whilst it is shown that earnings momentum can have an impact on equity prices of moderate-efficiency firms, its effect is minimal in explanatory terms and adds very little to parsimonious regression models based on earnings and book value alone. Earnings acceleration does not appear to impact on equity values - neither for the pooled sample data nor for any of the three efficiency sub-samples. The empirical analysis summarised in this dissertation also shows that there is a strong non-linear relationship between the market value of equity and the accounting information appearing in published financial reports for firms listed on the SSE. In particular, for low-efficiency firms liquidation option value appears to make a significant contribution to the overall market value of equity. For high-efficiency firms growth option value appears to make a significant contribution to the overall market value of equity. For firms with moderate operational efficiency real option value is negligible and thus for these firms the relationship between the market value of equity and the accounting variables on which the empirical analysis is based is approximately linear.</p>

Momentum, Acceleration and Non-Linearities in Equity Valuation on the Shanghai Stock Exchange

<p>The standard empirical paradigm for assessing the relationship between the market value of a firm’s equity and the accounting information appearing in the firm’s financial statements, is based on the assumption that the firm is indefinitely constrained to operate within its existing investment opportunity set. Based on this assumption, the Ohlson (1995) model, which is developed by characterising a firm’s investment opportunity set in terms of a first order vector system of stochastic differential equations, shows that the market value of a firm’s equity will be a linear combination of its current abnormal earnings, the current value of an “information” variable and the current book value of its equity. However, the pre-existing empirical evidence shows that the Ohlson (1995) model does not provide a satisfactory description of the relationship between the market value of a firm’s equity and the information appearing in its published financial statements. Recent developments in equity valuation theory also show that the higher order derivatives of the accounting variables comprising a firm’s investment opportunity set - that is, the momentum and acceleration of the accounting information disclosed in a firm’s financial statements - can potentially make a significant contribution to the overall market value of equity. This in turn will mean that a firm’s investment opportunity set ought to be characterised in terms of a second or third order system of stochastic differential equations. Omitting the momentum and acceleration of the accounting variables from the equity valuation process could lead to the under-estimation of equity values. Moreover, recent empirical evidence also shows that the market value of a firm’s equity is potentially, a complex non-linear function of a firm’s accounting information appearing in financial statements. The non-linear effects arise out of the adaptation (real) options associated with a firm’s ability to modify or even abandon its existing investment opportunity set. However, empirical work on the relationship between the market value of equity and the accounting information appearing in financial statements continues to be based on linear models which do not take account of either the momentum and acceleration in a firm’s accounting variables or the non-linear effects associated with the real options available to the firm. Given this, it is all but inevitable that when these valuation effects are ignored, systematic biases will arise in empirical work dealing with the determinants of equity values. Moreover, empirical work in this area has been almost exclusively based on North American and European data. There is, in particular, a dearth of empirical work in developing countries like the People’s Republic of China. This dissertation refines the equity valuation models summarised in the literature by incorporating momentum, acceleration and non-linear equity valuation effects and then empirically tests them against data obtained from the Shanghai Stock Exchange (SSE). The empirical analysis summarised in this dissertation shows that neither earnings momentum nor earnings acceleration exhibit a significant impact on the market value of equity for the pooled sample data on which the empirical analysis is based. However, when the pooled sample data are divided into three equally numerous groups based on each firm’s operational efficiency, earnings momentum for firms with moderate operational efficiency exhibits a significant association with the market value of equity. This contrasts with the low-efficiency and high-efficiency sub-sample firms, where earnings momentum appears to have an imperceptible effect on equity prices. However, whilst it is shown that earnings momentum can have an impact on equity prices of moderate-efficiency firms, its effect is minimal in explanatory terms and adds very little to parsimonious regression models based on earnings and book value alone. Earnings acceleration does not appear to impact on equity values - neither for the pooled sample data nor for any of the three efficiency sub-samples. The empirical analysis summarised in this dissertation also shows that there is a strong non-linear relationship between the market value of equity and the accounting information appearing in published financial reports for firms listed on the SSE. In particular, for low-efficiency firms liquidation option value appears to make a significant contribution to the overall market value of equity. For high-efficiency firms growth option value appears to make a significant contribution to the overall market value of equity. For firms with moderate operational efficiency real option value is negligible and thus for these firms the relationship between the market value of equity and the accounting variables on which the empirical analysis is based is approximately linear.</p>

Mapping the scientific research on alternative momentum investing: a bibliometric analysis

PurposeThis study aims to recognize the current dynamics, prolific contributors and salient trends and propose future research directions in the area of alternative momentum investing.Design/methodology/approachThe study uses a blend of electronic database and forward reference searching to ensure the incorporation of all the significant studies. With the help of the Scopus database, the present study retrieves 122 research papers published from 1999 to 2020.FindingsThe results reveal that alternative momentum investing is an emerging area in the field of momentum investing. However, this area has witnessed an exponential growth in last ten years. The study also finds that North American, West European and East Asian countries dominate in total research publications. Through network citation analysis, the study identifies five major clusters: industrial momentum, earnings momentum, 52-week high momentum, time-series momentum and risk-managed momentum.Research limitations/implicationsThe present review will serve as a guide for financial researchers who intend to work on alternative momentum approaches. The study proposes several unexplored research themes in alternative momentum investing on which future studies can focus.Originality/valueThe study embellishes the existing literature on momentum investing by contributing the first bibliometric review on alternative momentum approaches.

Do Hedge Funds Arbitrage on Asset Growth, Earnings Momentum and Equity Financing Anomalies?

This paper analyzes the risk-adjusted performance of hedge funds and their overall ability to arbitrage on known market anomalies. This is done by testing three anomaly factors capturing total asset growth, equity financing, and earnings momentum in addition to the traditional Fama and French (1993) and Carhart (1997) four-factor model and Fung and Hsieh (2001) risk factors. Our results suggest that the average hedge fund employs a strategy consistent with the total asset growth and earnings momentum anomalies but contradictory to the equity financing anomaly of Hirshleifer and Jiang (2007). Multi-factor alpha generation does seem to persist over longer periods of time which suggests the use of other untested, return-generating arbitrage methods.

Hedge Funds and Earnings Momentum

This study determines if hedge funds take advantage of the earnings momentum anomaly. A five-factor model was used including Fama and French (1993) and Carhart (1997) factors as well as an earnings momentum factor based on Chordia and Shivakumar (2007). The average hedge fund does not take advantage of the post-earnings momentum drift; however, larger funds associated with equity long only and equity short bias strategies successfully arbitrage on the earnings anomaly, contributing 2-3% per year, respectively. In contrast, funds with event driven, fund timing, and convertible arbitrage strategies tend to employ a strategy opposite to that of the earnings momentum anomaly and suffer losses accordingly.

Profitability of Style based Investment Strategies: Evidence from India

In this paper, we aim to identify profitable investment styles on the Indian stock market by using various combinations of important stock pricing anomalies consisting of. size, value, volume, profitability, earnings surprises, short term and long term prior returns. Using NSE200 stocks, three different investment styles viz. univariate, independent bivariate and conditional bivariate are constructed for the period July 2005-June 2016.Results show that on an absolute return basis, bivariate strategies do not seem to outperform univariate strategies. The unifactor CAPM is able to absorb 42% of the returns owing to the explanatory power of beta. After adjusting for risk using the three factor Fama and French (1993) model, 42% of the alphas are explained. However, additional risk factors from the Carhart (1997) model and Fama and French (2015) model do not provide any incremental explanatory power over the three factor model, recommending the use of the latter as a baseline to evaluate investment strategies in India. The highest supernormal returns of 1.1% per month are obtained from combining attributes and employing the conditional bivariate investment strategy viz.E2L1 (earnings momentum-Liquidity), M2S1 (price momentum-size), E2M3 (earnings momentum-price momentum). The findings are pertinent to portfolio managers, financial regulators and other stakeholders.

The Trend in Firm Profitability and the Cross-Section of Stock Returns

ABSTRACT This study shows that the recent trajectory of a firm's profits predicts future profitability and stock returns. The predictive information contained in the trend of profitability is not subsumed by the level of profitability, earnings momentum, or other well-known determinants of stock returns. The profit trend also predicts the earnings surprise one quarter later, and analyst forecast errors over the following 12 months, suggesting that sophisticated investors underreact to the information in the profit trend. On the other hand, we find no evidence of investor overreaction, and our results cannot be explained by well-known risk factors. JEL Classifications: G12; G14.