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Myopic Extrapolation, Price Momentum, and Price Reversal
Long Chen Washington University, St. Louis Claudia E. Moise Case Western Reserve University - Weatherhead School of Management Shelly Zhao Kent State University - Department of Finance November 9, 2009 Abstract: We find that last-year's winners have lower expected returns than losers. However, this is followed by prior winners experiencing more positive earnings shocks than losers for at least two quarters after portfolio formation. After that time frame, the relative earnings shocks display the opposite pattern. If investors, when valuing securities, were to myopically extrapolate current earnings shocks as if they were long-lasting, then we would observe price momentum in the short run, followed by reversal in the long run. This hypothesis has two unique predictions: (i) current earnings shocks propel investors to myopically adjust forecasts on future cash flows, from short run to long run; and (ii) current earnings shocks and revisions to expected future cash flows dominate past returns in explaining price momentum and reversal. We find strong support for both predictions in the data.
Keywords: Momentum, reversal, analyst forecast, earnings, expected return, realized return JEL Classifications: G12, G14 Working Paper SeriesDate posted: July 04, 2009 ; Last revised: November 10, 2009Suggested CitationContact Information
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