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Myopic Extrapolation, Price Momentum, and Price Reversal


Long Chen


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


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.

Number of Pages in PDF File: 50

Keywords: Momentum, reversal, analyst forecast, earnings, expected return, realized return

JEL Classification: G12, G14

working papers series


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Date posted: July 4, 2009 ; Last revised: November 10, 2009

Suggested Citation

Chen, Long, Moise, Claudia E. and Zhao, Xinlei Shelly, Myopic Extrapolation, Price Momentum, and Price Reversal (November 9, 2009). Available at SSRN: http://ssrn.com/abstract=1429612 or http://dx.doi.org/10.2139/ssrn.1429612

Contact Information

Long Chen (Contact Author)
Cheung Kong Graduate School of Business ( email )
Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China
Claudia E. Moise
Case Western Reserve University ( email )
10900 Euclid Ave.
369 Peter B Lewis Bldg
Cleveland, OH 44106-7235
United States
216-368-4778 (Phone)
Xinlei Zhao
Office of the Currency Comptroller - Risk Analysis Division ( email )
250 E Street, SW
Washington, DC 20219
United States
Kent State University - Department of Finance ( email )
College of Business Administration
P.O. Box 5190
Kent, OH 44242-0001
United States
330-672-1213 (Phone)
330-672-9806 (Fax)
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