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Sentiment and Momentum

54 Pages Posted: 27 Sep 2009 Last revised: 9 Mar 2014

John A. Doukas

Old Dominion University - Strome College of Business

Constantinos Antoniou

University of Warwick - Warwick Business School

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Date Written: January 10, 2010

Abstract

This paper sheds empirical light on whether sentiment affects the profitability of price momentum strategies. We hypothesize that news that contradicts investors’ sentiment causes cognitive dissonance, which slows the diffusion of signals that oppose the direction of sentiment. This phenomenon tends to cause underpricing of losers under optimism and underpricing of winners under pessimism. While the latter phenomenon can be corrected by arbitrage buying, short-selling constraints impede arbitraging of losers under optimism, causing momentum to be stronger in optimistic periods. Our empirical analysis supports this argument by showing that momentum profits arise only under optimism, and are driven principally by strong momentum in losing stocks. This result survives a host of robustness checks including controls for market returns, firm size and analyst following. An analysis of net order flows from small and large trades indicates that small (but not large) investors are slow to sell losers during optimistic periods. Momentum-based hedge portfolios formed during optimistic periods experience long-run reversals.

Keywords: behavioral finance, investor sentiment, momentum, market efficiency

JEL Classification: G12, G14

Suggested Citation

Doukas, John A. and Antoniou, Constantinos and Subrahmanyam, Avanidhar, Sentiment and Momentum (January 10, 2010). Available at SSRN: https://ssrn.com/abstract=1479197 or http://dx.doi.org/10.2139/ssrn.1479197

John A. Doukas

Old Dominion University - Strome College of Business ( email )

2080 Constant Hall
Suite 2080
Norfolk, VA 23529-0222
United States
757-683-5521 (Phone)

HOME PAGE: http://www.efmaefm.org/0DOUKAS/doukas.php

Constantinos Antoniou

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

Avanidhar Subrahmanyam (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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