The Inverse Relationship between ROE and Stock Returns in Chinese Stock Market

Abstract

This study analyzes the effect of Fama French 5 factor model in stocks returns on Chinese A-share market. We select all A shares from May 2000 to April 2019, 228 months. We find that in average excess returns for the 25 Size-OP portfolios and 32 Size-B/M-OP portfolios, small size and lowest operating profitability stock portfolios have a higher excess return than small size and highest OP stock portfolios. Through regression, we find that the five-factor model has explanatory power for excess returns of the A-share market, but it is not better than the three-factor model. In the five-factor model, the size effect is most significant, operating profitability factor has a significant effect in explanatory excess returns but RMW’s t-value is too low to reject zero and needs more research. Investment and value effect is not significant in the A-share market. We also added a momentum factor and construct a six-factor model. The five-factor model and six-factor model have similar explanatory to the A-share market, but UMD factor performs better than CMA factor.