Maxing Out in China: Optimism or Attention?

Abstract

Bali et al. (2011) document a maximum daily returns (MAX) premium in the US where stocks with the highest MAX underperform stocks with the lowest MAX in the subsequent month. However, the source of this MAX premium is contentious. Fong and Toh (2014) find that the MAX premium exclusively follows high sentiment periods suggesting that it is driven by investor optimism during high sentiment periods. In contrast Cheon and Lee (2017) find that the MAX premium is stronger following low sentiment periods suggesting that it is driven by the attention-grabbing characteristic of high MAX stocks in low sentiment periods. We present evidence from China consistent with the MAX premium being driven by investor optimism during high sentiment periods.

Anomalies in the China A-share market

“…Although Blitz et al (2014) offer several explanations for the existence of the low volatility effect, the explanation that low risk stocks are undervalued due to investors' preference for risky stocks with lottery-like payoffs predicts a strong effect in China. In accordance with this, there is widespread evidence that various measures of risk including maximum daily returns in the past month (MAX), an indicator for investor preference for lottery-like stocks, predict future returns; see Bali et al (2011) and for evidence for China Cheema et al (2020). Yao et al (2019) also find evidence of gambling behavior by retail investors in the Chinese stock market.…”

“…First, to account for a possible downward bias caused by trade suspensions, daily returns on suspended trading days are set equal to − 99. Second, as suggested by Cheema et al (2020), we aggregate the daily returns after a stock hits the upper price limit.…”