Uninformed Momentum Traders
44 Pages Posted: 9 Oct 2009 Last revised: 4 Jun 2010
This paper studies the relation between momentum trading and information. We present a variety of evidence supporting the hypothesis that momentum trading is linked to a lack of information. Firstly, using foreign portfolio flows in individual stocks we document significant momentum trading concentrated in stocks on which foreign investors potentially have more informational disadvantages. Small stocks, stocks with high volatility and low liquidity, and stocks that are internationally less visible are subject to greater momentum trading. In addition, stocks on which foreign trades indicate lower future profitability are subject to higher momentum trading. Secondly, we show that momentum trades exert contemporaneous price pressure and have no valuable longer-run information content. In two quarters following the momentum trades, stocks experience significant return reversal. Using the return reversal after momentum trades we also develop an implementable trading strategy that brings up to 8% per year. Thirdly, there is strong evidence that foreign investors neither possess local market specific information. We show that momentum trading is a sub-optimal investment strategy by showing the negative profitability of a strategy that buys past winners and sells past losers on the cross-section of stocks.
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