Market dynamics and momentum in the Taiwan stock market

• The frequent market transitions cause the absence of momentum premium in Taiwan.
• We document significantly positive momentum profits during market continuations.
• Our finding supports the overconfidence hypothesis.
• The market dynamic is unique and important in momentum investing in Taiwan.

Prior literature widely documents that the Taiwan stock market exhibits no momentum premium. We attribute this phenomenon to the frequent transitions of the market and hypothesize that the momentum strategy can be profitable when the effect of market dynamics is taken into consideration. Confirming this notion, we document significantly positive momentum profits in Taiwan when the market continues in the same state. The momentum strategy during periods of market transitions, however, exhibits significant reversals. We provide evidence in support of the overconfidence hypothesis in explaining our findings by showing that the significantly positive momentum profit is concentrated in stocks that attract more investor attention. Further investigations show that our results are robust to the inclusion of several conditioning variables, suggesting the uniqueness and importance of market dynamics in momentum investing in Taiwan.