Individualism and Momentum around the World Andy C.W. Chui: Hong Kong Polytechnic Sheridan Titman: UT Austin K.C. John Wei: HKUST December 2004 1 2 The Momentum Effect Momentum strategy: Buy the past winners and sell the past losers. Profitability of momentum strategy: Yes in the U.S. Jegadeesh and Titman (1993, 2001) Yes for most of the European countries Rouwenhorst (1998) Yes for a number of countries around the world. Griffin, Ji, and Martin (2003) No for most of the countries in Asia including Japan Chui, Titman, and Wei (2003) The evidence indicates that
Momentum effect varies across countries Cross-country differences in Momentum: Existing Views Momentum effect is stronger in countries with better investor protection. Chui, Titman, and Wei (2003) Momentum strategy is more profitable in common law countries than in civil law countries. Hong, Lee, and Swaminathan (2003) Momentum strategy is more profitable in countries with less corruption problem. Problems with these findings: Their sample sizes are small.
Chui et. al. (2003): Eight Asian Countries Hong et. al. (2003): Eleven Countries. 3 Cross-country differences in Momentum: A New Look Momentum effect is positively related to the degree of individualism across countries. Using data from forty-one countries, we find that the average monthly returns on zero-cost momentum portfolios are more than 0.5% higher in countries with individualism indexes in the top 30% than those countries with indexes in the bottom 30%. 4 Conceptual Framework Higher Degree of Individualism/ Lower Degree of Collectivism More Emphasis on Independent-self/
More Emphasis on Interdependent-self More Overconfidence & Self-attribution bias/ Less Overconfidence and Self-attribution bias Stronger Momentum Effect/ Weaker Momentum Effect 5 6 Individualism vs. Collectivism Individualism pertains to the degree to which people in a country tend to have an independent rather than an interdependent self-construal, and the reverse is the case for collectivism (Hofstede (2001)). Independent self vs. Interdependent self Independent self-construal
a conception of the self as an autonomous, independent person. (Markus and Kitayama (1991, p.226)) To satisfy oneself, others DO NOT have an important role to play. Interdependent self-construal View themselves not as separate from the social context but as more connected and less differentiated from others. (Markus and Kitayama (1991, p.227)) To satisfy oneself, others DO have an important role to play. 7 8 Individualism and Overconfidence Overconfidence: People tend to over-estimate their ability. Because of their independent self-construal,
people in individualistic cultures are motivated to think themselves as stars, as winners as above average and as the repositories of special qualities. Heine et. al. (1999, pp.769-770) Evidences from psychology support this view (Markus and Kitayama (1991) and Heine et al. (1999)). 9 Individualism and Overconfidence Overconfidence: Gelfand et al. (2002) suggest that The self is served in individualistic cultures by being distinct from and better than others, in order to accomplish the culturally mandated task of being independent and standing out. By contrast, the self is served in collectivistic cultures by being accepted by others and by focusing on negative characteristics, in order to accomplish the culturally mandated task of being interdependent and blending in. (p.835) 10
Self-attribution bias Self-attribution bias Also known as Self-serving bias. It refers to the tendency of people to enhance or protect their self-esteem by taking credit for success and denying responsibility for failure. (Zuckerman (1979, p.245)) 11 Individualism and Self-attribution bias Evidences from psychology After a review of a large body of experiments, Heine et al. (1999) conclude that independence bears a clear relation with self-esteem and interdependence, on the other hand, was only weakly related to self-esteem (p.778). After a review of the studies on cross-cultural variation in self-attribution bias, Jari-erik Nurmi (1992) suggests that this cross-cultural difference is typically explained by Western individualism and the collectivist orientation of
Eastern cultures (p.70) 12 Individualism and Self-attribution bias Evidences from psychology Evidence suggests that the pattern of selfserving biases found in societies more supportive of independent selves, such as the United States, is not always found in societies in which interdependent selves receive stronger encouragement, such as Japan (Moghaddam (1998, p.167) 13 Overconfidence/Self-attribution bias and Momentum Daniel, Hirshleifer, and Subrahmanyam (1998) Overconfidence Investors overweight their private signals.
Self-attribution bias Overweight public signals that confirm their private signals and underweight those that do not. Momentum Therefore, public signals tend to reinforce previous private signals and this leads to the momentum effect. Individualism and Momentum: Hypothesis Since investors in individualistic cultures tend to be more overconfident and more prone to self-attribution bias, the momentum effects should be stronger in individualist cultures.
14 15 Data description Individualism Index On 66 countries. The higher the index value, the higher is the degree of individualism (Hofstede 2001). Monthly data on stocks February 1980 to June 2003. Datastream International (55 countries except the U.S.). For the U.S., we use CRSP. Data collected are stock returns, market capitalization, and trading volume. 16 Data description
Institutional variables: Legal system (La Porta et al. (LLSV, 1998)). Anti-director rights (LLSV 1998. The higher the index value, the better the legal protection). Accounting standards (LLSV 1998. The higher the index value, the better the accounting standards). Risk of Earnings management (Leuz et al. 2003. The higher the index value, the higher the risk of earnings management). Corruption perception index (Transparency International. The lower the index value, the higher the corruption level.) 17 Sample description Common Stocks Both domestic and foreign, which are listed on the major stock exchange in each country. Cross-listed stocks are included in their homecountry samples. Both active and dead stocks. Include only a stocks primary class, such the A-shares, the Bearer-shares.
18 Sample description Common Stocks To improve the quality of data obtained from Datastream International, we do the followings: For Datastream data, exclude stocks whose market capitalization is below the 5th percentile of all the stocks within each country in each month. For Datastream data, to hedge against possible data error, we only include stock returns within the 1 percentile and the 99 percentile of the return distribution in each month in each country. 19 Sample description More Criteria Each stock should have a return history of at least eight months. Each country should have at least 30 stocks in
any month during our sample period. Each country should have a return history of at least five years. Our final sample includes 41 countries and more than 20,000 individual stocks. 20 Market Capitalization (Big 10 in June 2003) 12000000 U S $ M illio n 10000000 8000000 6000000 4000000 2000000 0 Start End
0 N e th e r la n d s S p a in T a iw a n K orea Sw eden I n d ia B e lg iu m F in la n d M a la y s ia S in g a p o r e S o u th A fr ic a B r a z il G reece
A r g e n tin a N orw ay D enm a rk Isra el I r e la n d T h a ila n d C h ile S w itz e r la n d A u s tr ia T urkey P o r tu g a l I n d o n e s ia M e x ic o P o la n d
N e w Z e a la n d P h ilip p in e s P a k is ta n B a n g la d e s h U S $ M illio n 21 Market Capitalization (Other Countries) 450000 400000 350000 300000 250000 Start End 200000
150000 100000 50000 22 Winners vs. Losers Classified by past six-month returns. Winner portfolio (top one-third of the stocks in each country). Loser portfolio (bottom one-third of the stocks in each country). These portfolios are equally weighted. Six-month holding period. A one-month gap between the ranking period and the holding period. Returns are in U.S. dollars. 23 Momentum portfolios Overlapping momentum portfolios Jegadeesh and Titman (1993)
Country-average portfolio A portfolio that put equal weight on each country-specific momentum portfolio, i.e. each country will have the same weight regardless the number of stocks in each country. Country-neutral portfolio Includes all winners and losers in each country and each stock in this portfolio will have the same weight. World Momentum Effect Country-average portfolio Winner Loser W minus L
198103200306 1.462 (5.60) 0.925 (3.23) 0.537 (6.48) 198402200306 1.542 (5.39) 0.983 (3.13) 0.559 (6.06) Winner Loser W minus L
Momentum Effect (bottom 20 countries ranked by individualism index) 1.2 1 A v e r a g e m o n th ly p r o fits (% ) 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 26 Momentum Effect (top 21 countries ranked by individualism index) 1.8
A v e r a g e m o n th ly p r o fits (% ) 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 27 Individualism and Momentum Countryaverage 198402200306 Countryneutral 198402200306
Winner Loser W minus L Low 1.559 (4.03) 1.250 (2.89) 0.308 (2.22) 2 1.493 (4.61) 1.001 (2.90) 0.492 (4.75) High 1.574 (5.82) 0.735 (2.41)
1.542 (4.96) 0.774 (2.00) 0.768 (3.74) High-Low 0.067 (0.19) -0.502 (-1.24) 0.569 (2.59) 28 Fama-MacBeth Regressions The empirical model Mom Indv DL Anti it o 1
i 2 i 3 i Cpix Acct Emgt 4 i 5 i 6 i it
The empirical result, 198402-200306 o 0.556 (0.56) Indv DL 0.012 (2.79) 0.26 (1.57) Anti 0.011 (0.17) Cpix Acct Emgt 0.016 (0.51) -0.014 (-1.48) 0.001 (0.04) Robustness Test:
An Alternative Individualism Index GLOBEs Institutional Collectivism Index Obtained from the Global Leadership and Organizational Behavior Effectiveness Program. An updated measure of Hofstedes individualism index. Define IndvGLOBE=GLOBEs index times -1. Fama-MacBeth regressions Replace Indv with IndvGLOBE. We obtain similar findings: IndvGLOBE Cpix Emgt 0.431 (3.14) 0.081 (2.18) -0.028 (-2.37) 29
Robustness Test: Bootstrap Analyses We randomly generate data by randomly assigning individualism scores and other country characteristics to the forty-one countries in our sample. 1,000 random assignments. For each random assignment, we repeat the Fama-MacBeth regressions The bootstrap t-statistic for each parameter is calculated from the empirical distributions of the estimates which are generated from the regressions. 30 Robustness Test: The Bootstrap Analyses 31
The Bootstrap t-statistics Indv/ IndvGLOBE DL Anti Cpix Acct Emgt Hofstede 3.00 1.64 0.21 0.41 -1.56 0.07
GLOBE 3.39 0.66 -0.32 2.83 -1.22 -2.55 32 Conclusion The momentum effect is weaker in countries with less individualistic cultures. This finding can be viewed as support for the Daniel, Hirshleifer, and Subrahmanyam (1998) model. 33 Implications (1)
Culture can have an important effect on stock return patterns. Investors in different cultures interpret information in different ways and are subject to different biases. 34 Implications (2) Investors in less individualistic cultures may place too much credence on consensus opinions, and may exhibit herd like overreaction to conventional wisdom. We find that the book-to-market effect is stronger in less individualistic countries. Low-Indv Median-Indv High-Indv
BM effect the DHS 0.654% 0.325% 0.242% However, model implies that the BM effect is caused by overconfidence. Therefore, the DHS model will predict that the BM effect should be stronger in countries with more overconfidence. 35 Implications (3) Investors have a tendency to underreact to public information in the more individualistic cultures and to overreact to public information in the less individualistic cultures. 36 Supplementary Diagram (1) Cumulative profits on the country-average momentum portfolios
in the post-holding period 8 Cumulative profits (%) 6 4 2 Indv-low Indv-median Indv-high 0 1 2 3 4 5 6 7
8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 -2 -4 -6 Month relative to portfolio formation 37 Supplementary Diagram (2) Cumulative profits on the country-neutral momentum portfolios in the postholding period 6 C u m u la tiv e p r o fits (% ) 4 2 0 1 2
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