Momentum and Reversals when Overconfident Investors Underestimate Their Competition

Review of Financial Studies, Forthcoming

63 Pages Posted: 7 Jul 2017 Last revised: 22 Dec 2019

See all articles by Jiang Luo

Jiang Luo

Nanyang Technological University (NTU) - Division of Banking & Finance

Avanidhar Subrahmanyam

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

Sheridan Titman

University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: April 11, 2019

Abstract

We develop a model where overconfident investors overestimate their own signal quality but are skeptical of others’. Those investors who are initially uninformed believe that the early informed have learned little, leading the former investors to provide excess liquidity, which, in turn, causes underreaction and short-run momentum. Skeptical investors can also react to stale information, causing momentum, followed by reversals. Hence, skepticism generates both momentum and reversals; the latter are amplified if investors over-assess their own signal precision. We explain how long-run reversals can disappear while shorter-term momentum prevails, provide empirical implications, and link momentum to liquidity and price efficiency.

Keywords: momentum, reversal, cursedness, information trading

JEL Classification: G2, G12, G14

Suggested Citation

Luo, Jiang and Subrahmanyam, Avanidhar and Titman, Sheridan, Momentum and Reversals when Overconfident Investors Underestimate Their Competition (April 11, 2019). Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2997001 or http://dx.doi.org/10.2139/ssrn.2997001

Jiang Luo

Nanyang Technological University (NTU) - Division of Banking & Finance ( email )

S3-01C-75 50 Nanyang Avenue
Singapore, 639798
Singapore

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

Sheridan Titman

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-232-2787 (Phone)
512-471-5073 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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