Momentum and Reversal in Financial Markets with Persistent Heterogeneity

39 Pages Posted: 16 Feb 2018

See all articles by Giulio Bottazzi

Giulio Bottazzi

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM)

Pietro Dindo

Ca Foscari University of Venice - Dipartimento di Economia

Daniele Giachini

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM)

Date Written: February 9, 2018

Abstract

This paper investigates whether short-term momentum and long-term reversal may emerge from the wealth reallocation process taking place in speculative markets. We assume that there are two classes of investors who trade long-lived assets by holding constantly rebalanced portfolios based on their beliefs. Provided beliefs, and thus portfolios, are sufficiently diversified, all investors survive in the long-run and, due to waves of mispricing, the resulting equilibrium returns exhibit long-term reversal. If, moreover, asset dividends are positively correlated, investors’ profitable trades become positively correlated too, thus generating short-term momentum in equilibrium returns. We use the model to replicate the performance of the Winners and Losers portfolios highlighted by the empirical literature and to provide insights on how to improve upon them. Finally, we show that dividend positive autocorrelation is positively related to momentum and negatively related to reversal while diversity of beliefs is positively related to both momentum and reversal.

Keywords: Market Efficiency, Heterogeneous Beliefs, Speculation, Short-term Momentum, Long-term Reversal

JEL Classification: C60, D53, G02, G12, G14

Suggested Citation

Bottazzi, Giulio and Dindo, Pietro and Giachini, Daniele, Momentum and Reversal in Financial Markets with Persistent Heterogeneity (February 9, 2018). University Ca' Foscari of Venice, Dept. of Economics Research Paper Series No. 03/WP/2018, Available at SSRN: https://ssrn.com/abstract=3123568 or http://dx.doi.org/10.2139/ssrn.3123568

Giulio Bottazzi

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM) ( email )

Piazza Martiri della Liberta, 33
Pisa, I-56127
Italy
+39-050-883343 (Phone)
+39-050-883344 (Fax)

Pietro Dindo (Contact Author)

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy

Daniele Giachini

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM) ( email )

Piazza Martiri della Liberta, 33
Pisa, I-56127
Italy

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