Individualism, Uncertainty Avoidance, and Earnings Momentum in International Markets

Abstract

The literature shows that price and earnings momentum returns cannot be fully explained by risk-based theories. In an attempt to better understand the price momentum anomaly, Chui et al. [2010] document that the cultural factor of-individualism‖ influences price momentum returns, but that the cultural factor of-uncertainty avoidance‖ does not. The current study extends Chui et al. [2010] by examining the influence of individualism and uncertainty avoidance on earnings momentum profits, as theory suggests that unique characteristics associated with earnings momentum, relative to price momentum, give rise to significant effects for both these cultural factors. Using data from 41 countries, we show that the level of individualism in a country is positively associated with earnings momentum profits and that the level of uncertainty avoidance is negatively associated with earnings momentum profits. This study contributes to the ongoing quest to better understand the earnings momentum phenomenon.

National Culture and the Valuation of Cash Holdings

“…Our motivation to focus on the investors’ perspective stems from the rich literature in behavioral finance documenting the relevance of investor characteristics and biases to asset pricing. For example, prior literature documents that investor traits influence investment choice, trading volume, volatility, returns, and level of cash holdings (e.g., Grinblatt and Keloharju, ; Barberis and Shleifer, ; Gaspar et al., ; Kumar, ; Chui et al., ; Neamtiu et al., ; Hirshleifer, 2015; and Dou et al., ). Differences in national cultural characteristics present an opportunity to examine the effect of investors’ cultural traits on firm (and cash) valuation.…”

“…Additionally, these factors have been shown to affect a number of other corporate decisions and asset pricing attributes. Individualism is shown to influence corporate investments (Shao et al., 2010), momentum (Chui et al., ), corporate debt maturity (Zheng et al., ), earnings momentum profit (Dou et al., ), investors’ risk preferences (Rieger et al., ), post‐acquisition performance (Chakrabarti et al., 2009), and M&A activity (Ferris et al., ). Uncertainty avoidance is shown to have an effect on corporate debt maturity (Zheng et al., ), investors’ risk preferences (Rieger et al., ), and leverage decisions (Wang and Esqueda, ).…”

Do culture, sentiment, and cognitive dissonance explain the ‘above suspicion’ anomalies?

“…Thus, while there is a clear split between western and ESEA markets for momentum, the picture is mixed for earnings momentum. Nonetheless, as Dou et al () show, culture is clearly related to PEAD, as it has been shown to be for momentum by Chui et al ().…”

“…Similarly, in relation to earnings momentum, Hong et al () examine 11 markets and find significant profits for all of the western markets in their sample and only one (Hong Kong) of six ESEA markets. However, while Dou et al () find a significant relationship between zero‐investment earnings momentum strategies and culture, they find significant positive returns for most of the major western and ESEA markets (the exception being Singapore, where returns are insignificantly different from zero). Thus, while there is a clear split between western and ESEA markets for momentum, the picture is mixed for earnings momentum.…”

“…For example, behavioral‐based theoretical models have been developed by Daniel, Hirshleifer, and Subrahmanyam (1998), Barberis, Shleifer, and Vishny (1998), and Hong and Stein () based on either psychological biases (e.g., overconfidence, representativeness, self‐attribution bias) or bounded rationality within a heterogeneous trader model. In terms of empirical evidence, examples include the role of market state (Cooper, Gutierrez, & Hameed, ), macroeconomic risk or conditions (Chordia & Shivakumar, ; Liu & Zhang, ), international rather than national risk (Asness, Moskowitz, & Pedersen, ; Fama & French, ), culture (Chui, Titman, & Wei, ; Dou et al, ), sentiment (Antoniou et al, ), the role of aspects of information (diffusion, asymmetry) and conservatism (Chen, Chou, & Hsieh, 2017; Da, Gurun, & Warachka, ; Doukas & McKnight, ), arbitrage risk (Mendenhall, ), security analyst experience (Mikhail, Walther, & Willis, ), transaction costs (Agyei‐Ampomah, ), dispersion in analysts’ forecasts and analyst forecast errors (Dische, ; Kang, Khurana, & Wang, ), and corruption and investor protection (Hong, Lee, & Swaminathan, ), among others. However, despite this work the reasons for the existence of profits from momentum strategies and PEAD remain unclear.…”