Short-Term Reversals and Longer-Term Momentum Around the World: Theory and Evidence

Abstract

Stock returns exhibit reversals at short horizons but slowly transition to momentum over longer horizons. To help understand this pattern, we develop a dynamic model with short- and long-horizon noise traders, informed investors, and uninformed investors who underreact to information they do not themselves produce. The model accords with the transition from reversals to momentum, and yields the following novel predictions: (i) attenuated reversals following earnings announcements, (ii) a negative relation between momentum and reversal profits across economies and time, and (iii) larger reversals when noise trading is more volatile. Empirical analysis using U.S. and international data supports these predictions.

Keywords: momentum, reversals, noise traders, liquidity, GameStop

JEL Classification: G02, G12, G14