Over or Under? Momentum, Idiosyncratic Volatility and Overreaction

37 Pages Posted: 7 Nov 2015 Last revised: 11 Nov 2015

See all articles by Mahdi Heidari

Mahdi Heidari

Stockholm School of Economics

Date Written: November 10, 2015

Abstract

Several studies have attributed the high excess returns of the momentum strategy in the equity market to investor behavioral biases. However, whether momentum effects occur because of investor underreaction or because of investor overreaction remains a question. Using a simple model to illustrate the linkage between idiosyncratic volatility and investor overreaction as well as the stock turnover as another measure of overreaction, I present evidence that supports the investor overreaction explanation as the source of momentum effects. Furthermore, I show that when investor overreaction is low, momentum effects are more due to industries (industry momentum) rather than stocks.

Keywords: Momentum, Idiosyncratic Volatility, Overreaction, Trading Volume, Industry Momentum

JEL Classification: G11, G12, G14, G17

Suggested Citation

Heidari, Mahdi, Over or Under? Momentum, Idiosyncratic Volatility and Overreaction (November 10, 2015). Available at SSRN: https://ssrn.com/abstract=2687480 or http://dx.doi.org/10.2139/ssrn.2687480

Mahdi Heidari (Contact Author)

Stockholm School of Economics ( email )

PO Box 6501
Stockholm, 11383
Sweden

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