1. 1 Individualism and Momentum around the World Andy C.W. Chui: Hong Kong Polytechnic Sheridan Titman: UT Austin K.C. John Wei: HKUST December 2004

2. 2 The Momentum Effect Momentum strategy: Momentum strategy: Buy the past winners and sell the past losers.Buy the past winners and sell the past losers. Profitability of momentum strategy: Profitability of momentum strategy: Yes in the U.S.Yes in the U.S. Jegadeesh and Titman (1993, 2001) Jegadeesh and Titman (1993, 2001) Yes for most of the European countriesYes for most of the European countries Rouwenhorst (1998) Yes for a number of countries around the world.Yes for a number of countries around the world. Griffin, Ji, and Martin (2003) No for most of the countries in Asia including JapanNo for most of the countries in Asia including Japan Chui, Titman, and Wei (2003) The evidence indicates that Momentum effect varies across countries

3. 3 Cross-country differences in Momentum: Existing Views Momentum effect is stronger in countries with better investor protection. Momentum effect is stronger in countries with better investor protection. Chui, Titman, and Wei (2003)Chui, Titman, and Wei (2003) Momentum strategy is more profitable in common law countries than in civil law countries. Momentum strategy is more profitable in common law countries than in civil law countries. Hong, Lee, and Swaminathan (2003)Hong, Lee, and Swaminathan (2003) Momentum strategy is more profitable in countries with less corruption problem. Momentum strategy is more profitable in countries with less corruption problem. Problems with these findings: Problems with these findings: Their sample sizes are small.Their sample sizes are small. Chui et. al. (2003): Eight Asian Countries Chui et. al. (2003): Eight Asian Countries Hong et. al. (2003): Eleven Countries. Hong et. al. (2003): Eleven Countries.

4. 4 Cross-country differences in Momentum: A New Look Momentum effect is positively related to the degree of individualism across countries. 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%.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%.

5. 5 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

6. 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)). 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)).

7. 7 Independent self vs. Interdependent self Independent self-construal Independent self-construal “a conception of the self as an autonomous, independent person.”“a conception of the self as an autonomous, independent person.” (Markus and Kitayama (1991, p.226)) (Markus and Kitayama (1991, p.226)) To satisfy oneself, others DO NOT have an important role to play. Interdependent self-construal Interdependent self-construal View themselves “not as separate from the social context but as more connected and less differentiated from others.”View themselves “not as separate from the social context but as more connected and less differentiated from others.” (Markus and Kitayama (1991, p.227)) (Markus and Kitayama (1991, p.227)) To satisfy oneself, others DO have an important role to play.

8. 8 Individualism and Overconfidence Overconfidence: Overconfidence: People tend to over-estimate their ability.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)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)). Evidences from psychology support this view (Markus and Kitayama (1991) and Heine et al. (1999)).

9. 9 Individualism and Overconfidence 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.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. 10 Self-attribution bias Self-attribution bias Self-attribution bias Also known as Self-serving 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.”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. 11 Individualism and Self-attribution bias Evidences from psychology 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 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)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. 12 Individualism and Self-attribution bias Evidences from psychology Evidences from psychology “Evidence suggests that the pattern of self- serving 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)“Evidence suggests that the pattern of self- serving 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. 13 Overconfidence/Self-attribution bias and Momentum Daniel, Hirshleifer, and Subrahmanyam (1998) Daniel, Hirshleifer, and Subrahmanyam (1998) Overconfidence Self-attribution bias Momentum Investors overweight their private signals. Overweight public signals that confirm their private signals and underweight those that do not. Therefore, public signals tend to reinforce previous private signals and this leads to the momentum effect.

14. 14 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. 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.

15. 15 Data description Individualism Index Individualism Index On 66 countries. The higher the index value, the higher is the degree of individualism (Hofstede 2001).On 66 countries. The higher the index value, the higher is the degree of individualism (Hofstede 2001). Monthly data on stocks Monthly data on stocks February 1980 to June 2003.February 1980 to June 2003. Datastream International (55 countries except the U.S.).Datastream International (55 countries except the U.S.). For the U.S., we use CRSP.For the U.S., we use CRSP. Data collected are stock returns, Data collected are stock returns, market capitalization, and trading volume. market capitalization, and trading volume.

16. 16 Data description Institutional variables: Institutional variables: Legal system (La Porta et al. (LLSV, 1998)).Legal system (La Porta et al. (LLSV, 1998)). Anti-director rightsAnti-director rights (LLSV 1998. The higher the index value, the better the legal protection). Accounting standardsAccounting standards (LLSV 1998. The higher the index value, the better the accounting standards). Risk of Earnings managementRisk of Earnings management (Leuz et al. 2003. The higher the index value, the higher the risk of earnings management). Corruption perception indexCorruption perception index (Transparency International. The lower the index value, the higher the corruption level.)

17. 17 Sample description Common Stocks Common Stocks Both domestic and foreign, which are listed on the major stock exchange in each country.Both domestic and foreign, which are listed on the major stock exchange in each country. Cross-listed stocks are included in their home- country samples.Cross-listed stocks are included in their home- country samples. Both active and dead stocks.Both active and dead stocks. Include only a stock’s primary class, such the A-shares, the Bearer-shares.Include only a stock’s primary class, such the A-shares, the Bearer-shares.

18. 18 Sample description Common Stocks 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 5 th percentile of all the stocks within each country in each month.For Datastream data, exclude stocks whose market capitalization is below the 5 th 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.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. 19 Sample description More Criteria More Criteria Each stock should have a return history of at least eight months.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 at least 30 stocks in any month during our sample period. Each country should have a return history of at least five years.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.

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22. 22 Winners vs. Losers Classified by past six-month returns.Classified by past six-month returns. Winner portfolio (top one-third of the stocks in each country).Winner portfolio (top one-third of the stocks in each country). Loser portfolio (bottom one-third of the stocks in each country).Loser portfolio (bottom one-third of the stocks in each country). These portfolios are equally weighted.These portfolios are equally weighted. Six-month holding period.Six-month holding period. A one-month gap between the ranking period and the holding period.A one-month gap between the ranking period and the holding period. Returns are in U.S. dollars.Returns are in U.S. dollars.

23. 23 Momentum portfolios Overlapping momentum portfolios Overlapping momentum portfolios Jegadeesh and Titman (1993)Jegadeesh and Titman (1993) Country-average portfolio 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.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 Country-neutral portfolio Includes all winners and losers in each country and each stock in this portfolio will have the same weight.Includes all winners and losers in each country and each stock in this portfolio will have the same weight.

24. 24 World Momentum Effect Country-average portfolio Country-average portfolio Country-neutral portfolio Country-neutral portfolio WinnerLoser W minus L 198103- 200306 1.462(5.60)0.925(3.23)0.537(6.48) 198402- 200306 1.542(5.39)0.983(3.13)0.559(6.06) WinnerLoser W minus L 198103- 200306 1.397(5.24)0.819(2.63)0.578(4.44) 198402- 200306 1.369(4.76)0.779(2.28)0.591(4.11)

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27. 27 Individualism and Momentum WinnerLoser W minus L Country- average 198402- 200306 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) 0.838 (6.76) High-Low 0.015 (0.05) -0.515 (-1.42) 0.530 (3.42) Country- neutral 198402- 200306 Low 1.475 (3.57) 1.276 (2.69) 0.200 (1.20) 2 1.209 (3.50) 0.908 (2.42) 0.301 (2.20) High 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. 28 Fama-MacBeth Regressions The empirical model The empirical model The empirical result, 198402-200306 The empirical result, 198402-200306 ooooIndvDLAntiCpixAcctEmgt0.556(0.56)0.012(2.79)0.26(1.57)0.011(0.17)0.016(0.51)-0.014(-1.48)0.001(0.04)

29. 29 Robustness Test: An Alternative Individualism Index GLOBE’s Institutional Collectivism Index GLOBE’s Institutional Collectivism Index Obtained from the Global Leadership and Organizational Behavior Effectiveness Program.Obtained from the Global Leadership and Organizational Behavior Effectiveness Program. An updated measure of Hofstede’s individualism index.An updated measure of Hofstede’s individualism index. Define Indv GLOBE =GLOBE’s index times -1.Define Indv GLOBE =GLOBE’s index times -1. Fama-MacBeth regressions Fama-MacBeth regressions Replace Indv with Indv GLOBE.Replace Indv with Indv GLOBE. We obtain similar findings:We obtain similar findings: Indv GLOBE 0.431 (3.14) Indv GLOBE 0.431 (3.14) Cpix 0.081 (2.18) Cpix 0.081 (2.18) Emgt-0.028 (-2.37) Emgt-0.028 (-2.37)

30. 30 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. 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. 1,000 random assignments. For each random assignment, we repeat the Fama-MacBeth regressions 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. The bootstrap t-statistic for each parameter is calculated from the empirical distributions of the estimates which are generated from the regressions.

31. 31 Robustness Test: The Bootstrap Analyses The Bootstrap t-statistics The Bootstrap t-statistics Indv/ Indv GLOBE DLAntiCpixAcctEmgt Hofstede3.001.640.210.41-1.560.07 GLOBE3.390.66-0.322.83-1.22-2.55

32. 32 Conclusion The momentum effect is weaker in countries with less individualistic cultures. 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. This finding can be viewed as support for the Daniel, Hirshleifer, and Subrahmanyam (1998) model.

33. 33 Implications (1) Culture can have an important effect on stock return patterns. 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. Investors in different cultures interpret information in different ways and are subject to different biases.

34. 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. 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.We find that the book-to-market effect is stronger in less individualistic countries. However, the DHS 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. However, the DHS 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. Low-IndvMedian-IndvHigh-Indv BM effect 0.654%0.325%0.242%

35. 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. 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. 36 Supplementary Diagram (1)

37. 37 Supplementary Diagram (2)