Myopic Extrapolation, Price Momentum, and Price Reversal

50 Pages Posted: 4 Jul 2009 Last revised: 10 Nov 2009

See all articles by Long Chen

Long Chen

Luohan Academy; Cheung Kong Graduate School of Business

Claudia E. Moise

Duke University, The Fuqua School of Business

Xinlei Shelly Zhao

Government of the United States of America - Office of the Currency Comptroller - Risk Analysis Division

Date Written: 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 Classification: G12, G14

Suggested Citation

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

Long Chen (Contact Author)

Luohan Academy ( email )

No. 556, Xixi Road, Z Space
Xihu District
Hangzhou, Zhejiang 310013
China
+86-0571-2688-8888-75520 (Phone)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Claudia E. Moise

Duke University, The Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States

Xinlei Zhao

Government of the United States of America - Office of the Currency Comptroller - Risk Analysis Division ( email )

250 E Street, SW
Washington, DC 20219
United States

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