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Int. j. econ. manag. soc. sci., Vol(5), No (2), June, 2016. pp.

23-27

TI Journals

International Journal of Economy, Management and Social Sciences


www.tijournals.com

ISSN:
2306-7276

Copyright 2016. All rights reserved for TI Journals.

Does Book-to-Market Ratio Matter in Profitability of Momentum


Investment Strategy in Tehran Stock Exchange?
Narjes Khosroazad *
M.A. in Finance, Kish Campus, University of Tehran, Tehran, Iran.

Hasti Chitsazan
Assistant professor, Faculty of Entrepreneurship, University of Tehran, Tehran, Iran.
*Corresponding author: nkha1389@gmail.com

Keywords

Abstract

Momentum Investment Strategy


Book-to-Market Ratio (BTM)
Efficient Market
Behavioral Finance

Momentum investment strategy is one of the axes which challenges Efficient Market Hypothesis that is one
of the fundamental paradigms in modern finance. Investment in growth and value stocks is also one of the
scholar axes about studying strategies generating surplus return in the market. The statistical population in
this research is the whole firms have been accepted in Tehran Stock Exchange. The firms have been
categorized based on the measure of Book-to-Market Ratio (BTM) and then their performance was studied.
Therefore, this research aims to study the impact of BTM (as a measure for differentiating between growth
and value stocks) on the profitability of momentum investment strategy in Tehran Stock Exchange. The
research was conducted during 2004-2014 and a sample of 40 firms was chosen from all accepted firms in
Tehran Stock Exchange by the knockout method. The results indicated that in the mentioned period,
differential return of winning and losing portfolio has been positive and this indicated positive profitability
of momentum investment strategy in both growth and value stocks.

1.

Introduction

According to Efficient Market Hypothesis (EMH) information entry to market and its impact on prices is random and price change trend and its
behavioral pattern is random and irregular, in fact, price is a function of random walk, the market does not have memory, and tomorrow cannot
be concluded based on prices of previous day. In other words, next path cannot be predicted through studying previous path.
Efficient Market Hypothesis achieved the most dominance in the world financial circles in 70 and 80 decades. But trust in this hypothesis was
gradually shaken due to behavioral irregularities in stock market and patterns inconsistent with modern financial theories and also observing
incidents such as financial market bubbles in the US in 1987 and other markets, and other events in capital markets.
Conducted study indicates the fact that common stock return in different time periods has especial behavior and individual investors can achieve
return more than market return through its historical tracking, without bearing more risk and merely by adopting appropriate investment strategy.
Studies have also indicated that in the time period of 3 to 12 months, there is a return continuity or momentum in the behavior of common stock
return and therefore investment return can be increased through adopting momentum investment strategies. Therefore, this research studies the
profitability of the momentum investment strategy which is proved in many developed as well as emerging markets and the impact of BTM
(Book-to-Market Ratio) on the strategy in Tehran Stock Exchange.

2.

Literature review

One of the characteristics of efficient market is failure in applying specific transaction rules for analyzing unexpected return. In other words,
investors cannot increase their return through applying some certain transaction strategies in comparison with other investors. Other
characteristics of efficient market are rational behavior of investors, transparency, existence of correct information systems and appropriateness
of operational and regulatory rules and regulations. But, in spite of Efficient Market Hypothesis which is the basis of many theories in finance,
one of the most challenging observations in financial markets is that common stock return has especial behaviors in different time periods.
Momentum and reverse strategies are used in the capital markets in the world and their usefulness in creating abnormal return has been
confirmed.
2.1 Momentum investment strategy
Momentum is a concept which has entered financial and investment domains from physics (Newtons first law) and is mostly defined as the
continuity of a path or direction. Considering momentum transactions, this means that stocks which have had price increase are expected to
increase in the next short and midterm periods. In return, stocks which have had price decrease in the past are expected to have price decrease in
the next period. If this effect exists in the market, it is expected to achieve abnormal unexpected return comparing with market and in this case it
is expected to reject weak form of efficient market hypothesis which is under consideration in stock markets.
First time Jegadeesh and Titman (1993) examined three to twelve months midterm periods studying the US stock market and achieved
considerable positive return in the whole holding periods by using the equally weighted method. They claimed that an investment strategy based
on stock borrowing strategy which has had the best and the worst performance during previous six months results in about 12.01% annual
abnormal return in the US stock market. This is a considerable return in the market and shows that the weak form of efficient market hypothesis
is rejected because historical data have the prediction power in selecting the best and the worst stock in the future.
Rouwenhorst (1998) studied a sample consisting of 2190 stocks from 12 European capital markets in the period of 1978-1995. Using the equally
weighted method in forming the portfolio, he realized that there is a momentum effect in the whole these 12 markets and winning portfolios have
better performance comparing to losing portfolios (about 1% per month after moderating the risk). He also studied the effect of size on the
momentum return and realized that momentum is more for the small stocks in comparison with big stocks.

Narjes Khosroazad *, Hasti Chitsazan

24

International Journal of Economy, Management and Social Sciences Vol(5), No (2), June, 2016.

Cleary and Inglis (1998) showed that using momentum strategy in Canada stock market, abnormal return can be achieved, but this profitability is
an indicator of risk acceptance and this reward of risk acceptance is variable during the time. They also realized that this strategy may not be
appropriate for inconsiderable investors who have more transaction costs.
Conrad and Kaul (1998) confirmed the success of the reverse investment strategy in long-term and momentum strategy in mid-term. In their
viewpoint, the profitability of momentum portfolios in short-term was because of temporary differences in expected returns. They reasoned that
momentum profits are a byproduct of this issue and some stocks will become riskier due to unknown risk factors and abnormal return is a result
of unknown systematic risk.
Moskowitz and Grinblatt (1999) calculated monthly returns of industries based on portfolio formation using value weighted by studying existing
stocks in NYSE, AMEX and NASDAQ and categorized them into 20 industries based on two first digit of the SIC code. Results indicated that
especial momentum return is generally not various. They mentioned that momentum return is practically resulting from the industry in which the
firm is placed.
Chan, Hameed and Tong (2000) studied existence of momentum effect in international index of stock and realized that momentum is not only
prevalent in emerging markets but also in all markets and when the holding period reaches 4 months, this strategy reaches to its strongest form.
They achieved abnormal positive return in the short term via portfolio formation by stock value weight method. In addition, they realized that
after moderating the risk, the return will basically decrease. One of their key findings is that when using momentum strategy, increase in the
transactions volume in the formation period will result in more momentum returns.
Liu and Lee (2001) achieved negative return of about 5% per month in Japan stock market in the time period 1975-1997. In fact, the results
indicated that Japan stock market moves in the reverse direction of momentum strategy and this is mostly limited to the first month of holding
period of small stocks. According to them, this indicates that there is a recursive element in the first month of portfolio holding period.
Hameed and Kusnadi (2002) studied 6 emerging Asian stock markets from 1981 to 1994 and achieved significant and small extraordinary profits
in this time period by using 6-month holding period. However, they realized that this issue is not true in all markets and is usually true in the
stocks with a low flow ratio. After moderating size and liquidity, they realized that these returns are not considerable and not that significant.
They concluded that Asian market do not have a correlation with American markets in reaction type to previous stock information.
Griffin, Ji, and Martin (2003) studied momentum strategy in forty countries in the farthest parts of the world and the results indicated that
momentum strategy is profitable in North America, Europe and Latin America but does not have considerable profitability in Asia.
George and Hwang (2004) studied 52-week momentum strategy by studying existing stocks in the US market in the time period 1963-2001 and
considering 6-month formation period. Based on this theory, they formed equally-weighted portfolios by classifying the stocks based on the ones
which had the nearest price to their highest price during previous 52 weeks. 30% of the stocks at the top of the portfolio list was called
winning and 30% of the stocks at the bottom of the portfolio list was called losing. Then they could create positive abnormal returns by
purchasing winning portfolio and selling losing portfolio.
Korajczyk and Sadka (2004) studied the impact of stock price movement as a result of voluminous transactions on the abnormal returns gained
from momentum strategy. They realized that by applying effective models on the price, returns decreases in accordance with portfolios sizes.
They mentioned that capital size break-even point is about 5 billion dollars for the extraordinary profits which are not accessible. They also
indicated that equally weighted portfolios have better performance in contrary to the portfolios with stock value before considering transactions
cost. This is the result of investment in assets which are more cashable and are based on stock value weight portfolio formation. They formed
portfolios based on liquidity which showed more abnormal returns in comparison with stock value weight portfolios after considering price
impact.
Demir, Muthuswamy and Walter (2004) studied stock price momentum in Australia markets. Their study was conducted using 462 stocks in
ASX market and also 722 existing stocks in the whole stock index during 1990 to 2001. They utilized time horizons of 30, 60, 90 and 180 days
and realized that stocks with previous return more than mean , tend to perform better in the holding period and stocks whose previous returns are
less than mean, perform more weakly in the holding period. Therefore, they achieved statically meaningful returns about 34.5% to 46% per
month depending on selected formation-holding period that this return was more than previous findings in Europe and the US stock markets.
By calculated momentum profits in England stock markets with portfolios with different weights, Siganosa (2007) claimed that this issue is
ignored in previous researches. Results indicated that investors can maximize their profit via buying/selling only a few stocks at the same time.
They will achieve high return by buying the first winning portfolio and shore selling the last losing portfolio. Furthermore, buying and selling
fewer stocks results in less brokerage costs and other transaction costs. He also reported that buying a winning portfolio including 10 stocks with
the biggest size and shore selling a losing portfolio including 10 stocks with the smallest size would result in monthly momentum profit about
45.3%. Because expected return increases when the risk increases, investment risk in boundary stocks will potentially increase when the return
increases and vice versa.
Foster and Kharazi (2008) studied the behavior of 50 highly active firms in Tehran Stock Exchange and using weekly data they concluded that in
the studied time period, return continuity is observed in Tehran Stock Exchange and momentum investment strategy is profitable.
2.2 Growth and value investment strategies
In the most exchange markets, researchers have performed widespread studies about efficiency of different investment strategies. The main
reason of financial experts to study investment strategies is not being able to analyze existing information in the market and investors not having
enough expertise.
Researchers have categorized investment strategies from various viewpoints and approaches. One of the most prevalent classification, around
which the majority of academic studies have been performed, is the growth and value strategy [5]. Value stock (cheap stock) is a kind of stock
that the ratio of market value to their book value or the ratio of price to their earning is low, and growth stock (expensive stock) is a kind of stock
that their ratio of market value to book value or the their ratio of price to earning is high. Since expensive stocks have higher risks in comparison
with cheap stocks, a stock portfolio which has many expensive stocks, have much different returns from one year to another year. Therefore
more return is expected from them and unfortunately the market is often surprised in these cases. In contrast, market expects cheap stocks less
return, in this case, their periodical return is more stable and market is less surprised.
This is a reality that expensive stocks have high risk and low return and cheap stocks possess low risk and high return. This point is one of the
most important inventions and discoveries in new finance and it is expected that the riskiest stocks create the least return in the future, but the
least risky stocks can have more return [4]. Lakonishok, Shleifer and Vishny (1994) compared stocks values which had lower market prices in
comparison with their intrinsic value with growth stock value (stocks which have low BTM ratio). They found out a return over 10 to 11 percent
per year in the stocks which do not have an extra risk.
Laporta, Lakonishok, Shleifer and Vishny (1997) considered stocks values and investors expectation from stocks price in the NYSE, AMEX
and NAZDAQ and mentioned that due to the investors wrong expectations, value stocks (stocks which have high BTM ratio) tend to perform
better in the next periods.

25

Does Book-to-Market Ratio Matter in Profitability of Momentum Investment Strategy in Tehran Stock Exchange?
International Journal of Economy, Management and Social Sciences Vol(5), No (2), June, 2016.

3.

Research hypotheses

Hypothesis 1: Differential return average of winning-losing portfolios in the stock classification with the most BTM is larger than zero.
Sub-hypothesis 1-1: Differential return average of winning-losing portfolios in the stock classification with the most BTM for 3formation and holding period is larger than zero.
Sub-hypothesis 1-2: Differential return average of winning-losing portfolios in the stock classification with the most BTM for 6formation and holding period is larger than zero.
Sub-hypothesis 1-3: Differential return average of winning-losing portfolios in the stock classification with the most BTM for 9formation and holding period is larger than zero.
Sub-hypothesis 1-4: Differential return average of winning-losing portfolios in the stock classification with the most BTM for 12formation and holding period is larger than zero.

monthmonthmonthmonth-

Hypothesis 2: Differential return average of winning-losing portfolios in the stock classification with the least BTM is smaller than or equal to
zero.
Sub-hypothesis 2-1: Differential return average of winning-losing portfolios in the stock classification with the most BTM for 3- monthformation and holding period is smaller than or equal to zero.
Sub-hypothesis 2-2: Differential return average of winning-losing portfolios in the stock classification with the most BTM for 6- monthformation and holding period is smaller than or equal to zero.
Sub-hypothesis 2-3: Differential return average of winning-losing portfolios in the stock classification with the most BTM for 9- monthformation and holding period is smaller than or equal to zero.
Sub-hypothesis 2-4: Differential return average of winning-losing portfolios in the stock classification with the most BTM for 12- monthformation and holding period is smaller than or equal to zero.

4.

Methodology

Regarding the fact that the main goal of this research is assessing profitability of Momentum investment with the impact of BTM in Tehran
Stock Exchange in the time period 2004-2014, it can be said that from goal viewpoint this research is among practical researches and because the
library method is utilized, this research is descriptive survey from the nature and method viewpoint.
4.1 Statistical population and sample selection
Statistical population of present research is the whole accepted firms in Tehran Stock Exchange. Since symbol of many firms in the Tehran
Stock Exchange is closed for a long time and is not traded, the firms must be studied that their symbol has not been closed for a long time in the
studied period. Therefore, the sample consisted of 40 firms in Stocks Market which have been selected by the knockout method among different
industries on the condition that firstly, their symbol has been open in at least 50% of transaction days and secondly, they have been listed in the
Stock market since 2004.
4.2 Data collection method
In this research, formation and holding periods are 3 months, 6 months, 9 months and 12 months.
For studying the impact of BTM on the profitability of momentum strategy, after data extraction and calculating research variables (BTM and
profitability), first existing stocks in the sample were ranked in descending order by excel based on BTM ratio in the portfolio formation period
(i month ago). 30% of the existing stock in the sample which had the most degree of BTM, formed top classification, and 30% which had the
least degree of BTM, formed bottom classification.
Then in each of these classifications 30% of stocks which had the most and the least return were calculated in order to specify winning and
losing portfolio for the next j months. Then 158 portfolios were formed in various time horizons by the equally- weighted method for rebuilding
and simulating momentum strategy with the impact of BTM ratio were formed in different time horizons. Eventually differential return was used
in order to test hypotheses.
4.3 Data analysis method
In this research two main hypotheses and 8 sub-hypotheses are considered in order to present a correct judgment about momentum strategy
profitability with the impact of BTM (Book-to-Market Ratio) in Tehran Stock Exchange. Different values of i and j in this research are as below:
Fi Kj = Portfolios with the i-month formation period and j-month holding period
i, j { 12,9,6,3}
First by One-Sample klomogorov Test, the normality of population was assessed and then by SPSS software and One-sample-test significance of
differential returns was studied.

5.

Research results

5.1 Testing hypothesis 1


Hypothesis 1: Differential return average of winning-losing portfolios in the stock classification with the most BTM is larger than zero.
In order to test this hypothesis in different time periods, four sub-hypotheses were compiled and studied. Return resulting from utilizing
momentum investment strategy with the impact of most BTM in 3-month, 6-month, 9-month and 12-month time periods in two groups of
winning and losing portfolios and portfolios differential return average were studied (Table 1 and Table 2).
Table 1. Variable Descriptive Statistics (Hypothesis 1)
Strategy
(Sub-hypothesis)
F3 K3
F6 K6
F9 K9
F12 K12

Portfolios No.

Return Mean

Std.

Std. Error Mean

39
19
12
9

0.059
0.099
0.103
0.123

0.048
0.084
0.096
0.079

0.007
0.019
0.028
0.028

Narjes Khosroazad *, Hasti Chitsazan

26

International Journal of Economy, Management and Social Sciences Vol(5), No (2), June, 2016.

Table 2. Inferential Statistics (Hypothesis 1)


test value=0
Strategy
(Sub-hypothesis)

Statistics
Test

Degree of
Freedom(df)

Sig.

Mean
Difference

F3 K3
F6 K6
F9 K9
F12 K12

7.764
5.156
3.727
4.634

38
18
11
8

0.000
0.000
0.003
0.002

0.059
0.099
0.103
0.123

95% Confidence Interval


of the Difference
Upper
Lower
0.075
0.044
0.140
0.059
0.164
0.042
0.184
0.062

5.1.1 Testing sub-hypothesis 1-1


Hypothesis 1-1: There are 39 portfolios with 3-month formation and holding period in this stage.
Significance value is 0.000 and with regard to the fact that significance value is less than 5 percent and also considering top and bottom limit,
zero hypothesis is rejected at the 95% confidence level. Based on this, it can be said that portfolio differential return average is positive in this
time period.
5.1.2 Testing sub-hypothesis 1-2
Sub-hypothesis 1-2: There are 19 portfolios with 6-month formation and holding period in this stage.
Significance value is 0.000 and with regard to the fact that significance value is less than 5 percent and also considering top and bottom limit, the
zero hypothesis is rejected at the 95% confidence level. Based on this, it can be said that portfolio differential return average is positive in this
time period.
5.1.3 Testing sub-hypothesis 1-3
Sub-hypothesis 1-3: There are 12 portfolios with 6-month formation and holding period in this stage.
Significance value is 0.003 and with regard to the fact that significance value is less than 5 percent and also considering top and bottom limit, the
zero hypothesis is rejected at the 95% confidence level. Based on this, it can be said that portfolio differential return average is positive in this
time period.
5.1.4 Testing sub-hypothesis 1-4
Sub-hypothesis 1-4: There are 9 portfolios with 6-month formation and holding period in this stage.
Significance value is 0.002 and with regard to the fact that significance value is less than 5 percent and also considering top and bottom limit, the
zero hypothesis is rejected at the 95% confidence level. Based on this, it can be said that portfolio differential return average is positive in this
time period.
5.2 Testing hypothesis 2
Hypothesis 2: Differential return average of winning-losing portfolios in the stock classification with the least BTM is smaller than or equal to
zero.
In order to test this hypothesis in different time periods, four sub-hypotheses were studied. Return resulting from utilizing momentum investment
strategy with the impact of most BTM in 3-month, 6-month, 9-month and 12-month time periods in two groups of winning and losing portfolios
and portfolios differential return average were studied (Table 3 and Table 4).
Table 3. Variable Descriptive Statistics (Hypothesis 2)
Strategy
(Sub-hypothesis)
F3 K3
F6 K6
F9 K9
F12 K12

Portfolios No.

Return Mean

Std.

39
19
12
9

0.073
0.096
0.111
0.177

0.069
0.077
0.078
0.141

Std. Error
Mean
0.010
0.017
0.022
0.047

Table 4. Inferential Statistics (Hypothesis 2)


test value=0
Strategy
(Sub-hypothesis)

Statistics
Test

Degree of
Freedom (df)

Sig.

Mean
Difference

F3 K3
F6 K6
F9 K9
F12 K12

6.694
5.429
4.965
3.779

38
18
11
8

0.000
0.000
0.000
0.005

0.073
0.096
0.111
0.177

95% Confidence Interval


of the Difference
Upper
Lower
0.095
0.051
0.133
0.059
0.161
0.062
0.286
0.069

5.2.1 Testing sub-hypothesis 2-1


Sub-hypothesis 2-1: There are 39 portfolios with 3-month formation and holding period in this stage.
Significance value is 0.000 and with regard to the fact that significance value is less than 5 percent and also considering top and bottom limit, the
zero hypothesis is rejected at the 95% confidence level. Based on this, it can be said that portfolio differential return average is positive in this
time period.
5.2.2 Testing sub-hypothesis 2-2
Sub-hypothesis 2-2: There are 19 portfolios with 6-month formation and holding period in this stage.
Significance value is 0.000 and with regard to the fact that significance value is less than 5 percent and also considering top and bottom limit, the
zero hypothesis is rejected at the 95% confidence level. Based on this, it can be said that portfolio differential return average is positive in this
time period.

27

Does Book-to-Market Ratio Matter in Profitability of Momentum Investment Strategy in Tehran Stock Exchange?
International Journal of Economy, Management and Social Sciences Vol(5), No (2), June, 2016.

5.2.3 Testing sub-hypothesis 2-3


Sub-hypothesis 2-3: There are 12 portfolios with 6-month formation and holding period in this stage.
Significance value is 0.003 and with regard to the fact that significance value is less than 5 percent and also considering top and bottom limit, the
zero hypothesis is rejected at the 95% confidence level. Based on this, it can be said that portfolio differential return average is positive in this
time period.
5.2.4 Testing sub-hypothesis 2-4
Sub-hypothesis 2-4: There are 9 portfolios with 6-month formation and holding period in this stage.
Significance value is 0.005 and with regard to the fact that significance value is less than 5 percent and also considering top and bottom limit, the
zero hypothesis is rejected at the 95% confidence level. Based on this, it can be said that portfolio differential return average is positive in this
time period.

6.

Conclusion

The result of testing first main hypothesis indicated that differential return average of winning-losing portfolio in stock classification with the
most BTM was positive in different time periods and this shows positive profitability of momentum strategy in stock classification with the most
BTM in Tehran Stock Exchange. Furthermore, the result of testing second main hypothesis indicated that differential return average of winninglosing portfolio in stock classification with the least BTM was positive in different time periods and this indicated positive profitability of
momentum strategy in stock classification with the least BTM in Tehran Stock Exchange.
Therefore, in financial analysis of returns resulting from hypotheses testing it can be mentioned that in Tehran Stock Exchange, applying
momentum investment strategy results in profitability in both growth and value stocks groups, in the understudied periods.
Therefore, this research confirmed profitability of momentum strategy by equally-weighted method in two groups of value and growth stocks in
Tehran Stock Exchange. Among researchers who have confirmed achieving abnormal return via applying the momentum strategy, we suggest
Jegadeesh and Titman (1993) who used the equally-weighted method in America stocks market, Rouwenhorst (1998) who used the equallyweighted method with the impact of size on return in European stock market, Moskowitz and Grinblatt (1999) who utilized the method of valueweighted in the AMEX, NYSE, NAZDAQ and Foster and Kharazi (2008) who used the equally-weighted method in Tehran Stock Exchange and
achieved abnormal return by applying momentum strategy.

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