Arbitrage Strategy Based on DHS Pricing Model

Research Article
Open access

Arbitrage Strategy Based on DHS Pricing Model

Jiaxuan Li 1* , Yitong Chen 2 , Yumin Wu 3 , Dizhao Zhang 4 , Zhutian Gao 5
  • 1 The Chinese University of Hong Kong    
  • 2 Hong Kong Baptist Univeristy    
  • 3 Shanghai University of International Business and Economics    
  • 4 Zhongnan University of Economics and Law    
  • 5 New Jersey    
  • *corresponding author 120090093@link.cuhk.edu.cn
Published on 13 September 2023 | https://doi.org/10.54254/2754-1169/17/20231064
AEMPS Vol.17
ISSN (Print): 2754-1177
ISSN (Online): 2754-1169
ISBN (Print): 978-1-915371-77-5
ISBN (Online): 978-1-915371-78-2

Abstract

The Daniel-Hirshleifer-Sun (DHS) is a three-factor model based on the investor’s psychology. It supplements the market factors of the CAPM model with two behavioral factors that capture commonalities in mispricing resulting from psychological biases. The DHS method focuses on two psychological biases affecting asset prices: overconfidence and limited attention. According to Daniel, Hirshleifer, and Sun, overconfidence in the investor tends to induce commonality in long-horizon mispricing.In contrast, the inattention of the investor tends to induce commonality in short-horizon mispricing. In this strategy, assets are priced according to the DHS model, and the unexplained return generated from this model is traded. According to the back-test, the explanation power of the DHS model is limited in Chinses market. As a result, the arbitrage strategy based on this model cannot generate a decent return in the long run. However, this strategy generates a significant positive return in turbulent market conditions. During these periods, investors tend to panic, and their psychology is especially unstable, so the two behavioral factors can explain the return efficiently.

Keywords:

Daniel-Hirshleifer-Sun three-factor model, arbitrage strategy, Shanghai and Shenzhen stock market

Li,J.;Chen,Y.;Wu,Y.;Zhang,D.;Gao,Z. (2023). Arbitrage Strategy Based on DHS Pricing Model. Advances in Economics, Management and Political Sciences,17,76-90.
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References

[1]. Daniel, Kent, David Hirshleifer, and Lin Sun. 2019. "Short- And Long-Horizon Behavioral Factors". The Review Of Financial Studies 33 (4): 1673-1736. doi:10.1093/rfs/hhz069.

[2]. Belen Blanco (2012). Using CAPM and Fama and French Three Factor Model: portfolios selection. Public and Municipal Finance, 1(2).

[3]. Grace Xing Hu, Can Chen, Yuan Shao, and Jiang Wang, 2019. "Fama–French in China: Size and Value Factors in Chinese Stock Returns," International Review of Finance, International Review of Finance Ltd., vol. 19(1), pages 3-44, March.

[4]. Lian, Xiangbin and Liu, Yangyi and Shi, Chuan, A Composite Four-Factor Model in China (September 21, 2021). Available at SSRN: https://ssrn.com/abstract=3928587 or http://dx.doi.org/10.2139/ssrn.3928587.

[5]. Daniel, Kent D. and Hirshleifer, David A. and Sun, Lin, The FIN and PEAD Factors: Motivation, Construction, and Availability (September 11, 2020). Available at SSRN: https://ssrn.com/abstract=3691023 or http://dx.doi.org/10.2139/ssrn.3691023.

[6]. Cai Jun, 2004. "Bid-Ask Spreads for Trading Chinese Stocks Listed on Domestic and International Exchanges". City University of Hong Kong. Available at SSRN: Https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.459.5398&rep=rep1&type=pdf.

[7]. Daniel, K. D., Hirshleifer, D. A., & Sun, L. (2021). Teaching Slides on Short and Long Horizon Behavioral Factors. Columbia Business School Research Paper. Available at SSRN: https://ssrn.com/abstract=3849094 or http://dx.doi.org/10.2139/ssrn.3849094

[8]. Guo, Kun, Yi Sun, and Xin Qian. 2017. "Can Investor Sentiment Be Used To Predict The Stock Price? Dynamic Analysis Based On China Stock Market". Physica A: Statistical Mechanics And Its Applications 469: 390-396. doi:10.1016/j.physa.2016.11.114.

[9]. Wu, Yangru. 2010. "Momentum Trading, Mean Reversal And Overreaction In Chinese Stock Market". Review Of Quantitative Finance And Accounting 37 (3): 301-323. doi:10.1007/s11156-010-0206-z.

[10]. Zhang, Lishuang. (2022) An Empirical Study on the Components of Shanghai Stock Exchange 50 Index in China Based on CAPM Model and Fama-French Three Factor Mode.Economic Research Guide , 26:78-80.

Cite this article

Li,J.;Chen,Y.;Wu,Y.;Zhang,D.;Gao,Z. (2023). Arbitrage Strategy Based on DHS Pricing Model. Advances in Economics, Management and Political Sciences,17,76-90.

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The datasets used and/or analyzed during the current study will be available from the authors upon reasonable request.

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About volume

Volume title: Proceedings of the 2nd International Conference on Business and Policy Studies

ISBN：978-1-915371-77-5(Print) / 978-1-915371-78-2(Online)
Editor：Canh Thien Dang, Javier Cifuentes-Faura
Conference website: https://2023.confbps.org/
Conference date: 26 February 2023
Series: Advances in Economics, Management and Political Sciences
Volume number: Vol.17
ISSN：2754-1169(Print) / 2754-1177(Online)

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References

[1]. Daniel, Kent, David Hirshleifer, and Lin Sun. 2019. "Short- And Long-Horizon Behavioral Factors". The Review Of Financial Studies 33 (4): 1673-1736. doi:10.1093/rfs/hhz069.

[2]. Belen Blanco (2012). Using CAPM and Fama and French Three Factor Model: portfolios selection. Public and Municipal Finance, 1(2).

[3]. Grace Xing Hu, Can Chen, Yuan Shao, and Jiang Wang, 2019. "Fama–French in China: Size and Value Factors in Chinese Stock Returns," International Review of Finance, International Review of Finance Ltd., vol. 19(1), pages 3-44, March.

[4]. Lian, Xiangbin and Liu, Yangyi and Shi, Chuan, A Composite Four-Factor Model in China (September 21, 2021). Available at SSRN: https://ssrn.com/abstract=3928587 or http://dx.doi.org/10.2139/ssrn.3928587.

[5]. Daniel, Kent D. and Hirshleifer, David A. and Sun, Lin, The FIN and PEAD Factors: Motivation, Construction, and Availability (September 11, 2020). Available at SSRN: https://ssrn.com/abstract=3691023 or http://dx.doi.org/10.2139/ssrn.3691023.

[6]. Cai Jun, 2004. "Bid-Ask Spreads for Trading Chinese Stocks Listed on Domestic and International Exchanges". City University of Hong Kong. Available at SSRN: Https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.459.5398&rep=rep1&type=pdf.

[7]. Daniel, K. D., Hirshleifer, D. A., & Sun, L. (2021). Teaching Slides on Short and Long Horizon Behavioral Factors. Columbia Business School Research Paper. Available at SSRN: https://ssrn.com/abstract=3849094 or http://dx.doi.org/10.2139/ssrn.3849094

[8]. Guo, Kun, Yi Sun, and Xin Qian. 2017. "Can Investor Sentiment Be Used To Predict The Stock Price? Dynamic Analysis Based On China Stock Market". Physica A: Statistical Mechanics And Its Applications 469: 390-396. doi:10.1016/j.physa.2016.11.114.

[9]. Wu, Yangru. 2010. "Momentum Trading, Mean Reversal And Overreaction In Chinese Stock Market". Review Of Quantitative Finance And Accounting 37 (3): 301-323. doi:10.1007/s11156-010-0206-z.

[10]. Zhang, Lishuang. (2022) An Empirical Study on the Components of Shanghai Stock Exchange 50 Index in China Based on CAPM Model and Fama-French Three Factor Mode.Economic Research Guide , 26:78-80.

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