Chinese stock market efficiency challenged by combined liquidity-trading strategy evidence
image: First, when the time length is less than 28 days (0<M<28), TLSMAP increases monotonically with time length. TLSMAP peaks at M = 28 (0.0007), suggesting that the combined strategy has the highest profitability at the 28 day time length (about one month). When the time length is greater than 28 (28 < M ≤ 140), the TLSMAP curves decrease monotonically with time length. Second, when M is below 119 days, the TLSMAPs are positive; however, when M is greater than 119 days (119 < M≤140), the TLSMAPs start to turn negative. The TLSMAP intercept curves have similar patterns to the TLSMAP curves.
Credit: Bo Yu (City University of Macau, China)
Background and Motivation
The Chinese stock market, now the world's second largest, has attracted significant attention from global investors and researchers regarding its efficiency. While some studies suggest the market follows the Efficient Market Hypothesis (EMH), others present contradictory evidence. This ongoing debate, coupled with mixed results on the impact of China’s 2004 split-share reform, motivated researchers to develop a new approach to assess whether the market is truly weak-form efficient.
Methodology and Scope
The study introduces a novel combined liquidity trading strategy that integrates a liquidity premium buy-and-hold strategy with a technical trading strategy. Using a multidimensional liquidity proxy—constructed from the Amihud, Liu, and FHT ratios—the researchers classified stocks into decile portfolios based on liquidity levels. The strategy was tested on Chinese A-share data from January 1995 to December 2019, covering 1,549 firms and nearly 4 million firm-day observations. Robustness checks included transaction costs, market states, and policy reforms.
Key Findings and Contributions
- Market Inefficiency: The combined strategy generated significant excess returns throughout the sample period, indicating that the Chinese stock market does not comply with the weak-form EMH.
- Post-Reform Performance: Following the 2004 split-share reform, risk-adjusted excess returns became even more pronounced, suggesting the reform did not enhance market efficiency.
- Robust Results: Findings remained significant after accounting for risks, transaction costs, bull/bear markets, January effects, and short-selling reforms.
- Short vs. Long-Term Signals: The strategy was profitable with short-term technical signals (under 119 days) but not with long-term ones, which could help explain the mixed prior evidence.
Why It Matters
This research contributes to the ongoing debate on market efficiency in China by providing clear evidence against weak-form efficiency. It also clarifies the ambiguous role of the 2004 split-share reform, showing it did not lead to meaningful improvements in market efficiency. The findings are relevant for global investors assessing opportunities in Chinese equities and for policymakers evaluating the impact of structural reforms.
Practical Applications
- For Investors: The study suggests that combining liquidity-based strategies with technical analysis may yield excess returns, offering a potential approach to exploit market inefficiencies in China.
- For Policymakers: Results indicate that regulatory reforms such as the split-share reform may not automatically improve market efficiency, highlighting the need for deeper structural and institutional enhancements.
- For Researchers: The multidimensional liquidity proxy and combined strategy provide a refined framework for testing market efficiency in emerging markets, opening avenues for further comparative studies.
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