Momentum Investing and Cultural Differences


The effectiveness of momentum strategies in terms of cultural differences


The fundamental purpose of quantitative investment research is to identify patterns in the financial markets, to examine the validity of these patterns, and then to determine whether they occur by chance or whether they are repeatable. The ideal outcome is, of course, to find a "holy grail" that applies to every market, and if it applies to every market, the more likely it is to be universal and profitable. For this to happen, a prerequisite must be present: the hardware and software of each financial market must be similar, with hardware referring to the market structure, trading platforms and trading rules, and software referring to the market participants. The behavioural and psychological characteristics of market participants have a significant impact on the pricing of financial products and are the subject of research in behavioural finance.


Behavioural finance is a specialized subject that integrates psychological and behavioural science theories into . Behavioural finance recognises that the pricing of securities is influenced not only by fundamental and macro factors but also to a certain extent by the psychology and behaviour of investors.



Individualism reveals that profitability varies from place to place


Behavioural finance encompasses several psychological concepts, including mental accounts, herding behaviour, overconfidence or self-interested attribution. Overconfidence refers to people being overconfident in their abilities to make judgments. Self-interest attribution refers to people attributing their successes to themselves and their failures to their environment. These two concepts are closely related to the Momentum Strategy of quantitative strategies, which involves buying stocks that have been doing well recently and selling stocks that have been doing poorly. An overconfident investor places a high value on the information he has gathered. When publicly available information confirms his judgment, his confidence increases and he is more sure of his abilities, causing stock prices to overreact in the short term.


Initially, the research on momentum strategies was mainly focused on the US stock market, but gradually it was also applied in Europe, Japan and finally in emerging markets. It is generally found that momentum strategy works in a majority of the markets. However, the interesting point is that the magnitude of the momentum profit differs in different markets. In a 2010 paper by Chui, Titman and Wei, the authors provide an illuminating insight into why the profitability of momentum strategies differs from one market to another. They propose that there is a clear relationship between individualism and the effectiveness of momentum strategies. They used an index created by the social psychologist Hofstede in 2001 to quantify the degree of individualism in each place, which was based on a cross-country interview he conducted for IBM employees.


Japan returns minus 0.03% lagging behind the market

The magnitude of the Individualism Index aims to the reflect the cultural characteristics of the people in a certain place rather than to point out which way of thinking is better. A high value indicates a stronger focus of self-development and the benefits of his closed family. A low value indicates that one would emphasize more on his relationship with the society.

In the article of Chui et al, 41 countries were listed in the index. The US has a value of 91 while the UK has a value of 89. The index values in Asia are generally lower, with China at 20, Japan at 46 and Hong Kong at 25. To examine the relationship between the effectiveness of momentum strategies and individualism, the study selected one-third of the best-performing stocks in each market over the past six months to take a long position and one-third of the worst-performing stocks to take a short position and held both long and short positions for six months.


The study shows that long positions outperformed short positions in both the US and Europe, with long positions outperforming short positions by an average of 0.7% to 1.1% per month between 1981 and 2003, while the same applies to momentum strategies in Hong Kong, where long positions outperformed by 0.7% per month and China A-shares by 0.26% per month between 1993 and 2003.


It is worth mentioning the results of the Japanese market, although Japan is not lagging in terms of individualism, the return of momentum strategy is negative 0.03%. This particular phenomenon has been studied in depth by scholars, and it is suggested that momentum and value strategies should be considered together in the Japanese market to be meaningful. In addition to the analysis of individual regions, the article also divided all the markets into 3 groups according to the level of individualism index, forming 3 stock portfolios.


If a place is culturally collectivist, investors will tend to value the information and opinions provided by their peers rather than their judgments, which means that investors will not be over-confident or attribute their success to themselves. Therefore, the probability of success of momentum strategies is lower.

The above study was conducted in 2010, nine years ago, and in here we used the data from 2010 to 2019 to check whether there is any significant change in the effectiveness of the momentum strategy in various markets. The test uses a simple method of comparing the MSCI's Momentum Factor with the corresponding market capitalisation-weighted index to examine the additional return of the Momentum strategy. The MSCI Momentum Index is not available for all countries or regions, so a few indices with a long history have been selected for reference.


The Momentum Index outperformed the market cap index by 3% per annum in the US, 4.1% per annum in Europe and 1.8% per annum in Asia over the retesting period, in contrast to Japan where the Momentum Index underperformed the market cap index by 0.03% per annum. The results suggest that the effectiveness of momentum strategies may be diminished by arbitrage activity but there is still variation in the effectiveness of strategies, confirming the point that stock market rules and structures can change quickly, but cultural fundamentals do not change easily.

Data source: Rivermap

Note: Asness, "Momentum in Japan‥ The exception that proves the rule", The Journal of

Portfolio Management, Vol. 37, No. 4 (2011), pp. 67-75.