Information Percolation, Momentum, and Reversal

63 Pages Posted: 1 Nov 2014

See all articles by Daniel Andrei

Daniel Andrei

McGill University; Desautels Faculty of Management

Julien Cujean

Ecole Polytechnique Fédérale de Lausanne

Date Written: September 25, 2014

Abstract

We propose a rational model to explain time-series momentum. The key ingredient is word-of-mouth communication, which we introduce in a noisy rational expectations framework. Word-of-mouth communication accelerates information revelation through prices and generates momentum. Social interactions allow investors with heterogeneous trading strategies — contrarian and momentum traders — to coexist in the marketplace. As a result, momentum is not completely eliminated, although a significant proportion of investors trade on it. We also show that word-of-mouth communication spreads rumors and generates price run-ups and reversals. Our theoretical predictions are in line with several empirical findings.

Suggested Citation

Andrei, Daniel and Cujean, Julien, Information Percolation, Momentum, and Reversal (September 25, 2014). Available at SSRN: https://ssrn.com/abstract=2517016 or http://dx.doi.org/10.2139/ssrn.2517016

Daniel Andrei (Contact Author)

McGill University ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

Desautels Faculty of Management ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

Julien Cujean

Ecole Polytechnique Fédérale de Lausanne ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

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