The strategy trades Chinese A-shares, buying high-ROE and selling low-ROE stocks from the largest 30%, rebalancing monthly using operating profit and equity data from quarterly reports.
ASSET CLASS: stocks | REGION: China | FREQUENCY:
Monthly | MARKET: equities | KEYWORD: Profitability Factor, China
I. STRATEGY IN A NUTSHELL
The strategy trades large-cap Chinese stocks using profitability (ROE), going long on the highest quintile and short on the lowest, with monthly rebalancing.
II. ECONOMIC RATIONALE
High profitability predicts future returns; buying profitable firms and shorting low-profitability firms captures the profitability premium, consistent with q-theory and investment frictions.
III. SOURCE PAPER
Q-Theory, Mispricing, and Profitability Premium: Evidence from China [Click to Open PDF]
Fuwei Jiang, Xiamen University; Xinlin Qi, Industrial and Commercial Bank of China (ICBC) – Global Market Dept.; Guohao Tang, Hunan University – College of Finance and Statistics
<Abstract>
This paper investigates whether rational risk or behavioral mispricing helps to explain the profitability premium in the Chinese stock market setting. We find that firms with high profitability generate substantially higher future stock returns than those with low profitability in China. This positive effect of profitability on returns is robust after controlling for alternative firm characteristics and risks, and is stronger among firms with large capitalization and high growth. We further show that profitability premium is stronger among firms with low investment frictions, consistent with the implications of investment-based q-theoretical asset pricing models. However, it is not stronger among firms with high limits to arbitrage, not consistent with the behavioral mispricing based explanations.
