Myopic Extrapolation, Price Momentum, and Price Reversal
Cheung Kong Graduate School of Business
Claudia E. Moise
Case Western Reserve University
Xinlei Shelly Zhao
Office of the Currency Comptroller - Risk Analysis Division; Kent State University - Department of Finance
November 9, 2009
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.
Number of Pages in PDF File: 50
Keywords: Momentum, reversal, analyst forecast, earnings, expected return, realized return
JEL Classification: G12, G14working papers series
Date posted: July 4, 2009 ; Last revised: November 10, 2009
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo7 in 0.375 seconds