Testing investment strategies based on behavioral finance

Subject Areas : Journal of Investment Knowledge

Hashem Nikoomaram ¹ , Ali Saeedi ² , Kiarash Mehrani ³

1 - Professor of Islamic Azad University, Science & Research Branch
2 - Member of Board,Department of Management, North- Tehran Branch, Islamic Azad University
3 - Phd student of Islamic Azad University, Science & Research Branch

Received: 2016-05-29 Accepted : 2016-08-02 Published : 2017-02-19

Keywords: ARMS Index, momentum and reverse strategie, volatility, sentiments,

Abstract :

This study has tested momentum and reverse investment strategies in a behavioral finance framework, based on various optimistic, pessimistic and normal market sentiments. At the first step, sentiment Index by means of ARMS Adjusted Trading Index was measured. Then, making use of portfolio analysis, we formed portfolios for 1 month and 3 month periods based on momentum and reverse strategies. Portfolios classification was done based on volatility factor in various behavioral periods. Then returns of different portfolios and strategies was tested by a probit model in different market sentiments (i.e. optimism, pessimism and normal) Finding of the study reveal that in a normal market sentiment, most of behavioral finance strategies has been successful in terms of return. Moreover, reverse strategies have shown higher efficiency in a normal market state, compared to a momentum strategies. It was surprising when we found that both in a pessimistic and optimistic period, not only any excess return was experienced, but also mostly lead to loss. In short term, momentum portfolios produced higher return than reverse ones. Unit root test proved stationary of the sentiment. Since the market was found to be non-stochastic, we conclude stock market inefficiency. We found in a VAR model framework that optimism is a one-way Granger Couse of stock return, furthermore stock return is a one-way Granger Couse of pessimism.