Momentum, the Disposition Effect and Beta

Abstract

The existence of a premium to momentum portfolios, formed by buying recent winners and selling recent losers is widely accepted, although the source of the returns remains controversial. It remains a focus of behavioural finance. We focus on one set of explanations, based on prospect theory, specifically the disposition effect. This paper develops a model of stock price movement based on our interpretation of the disposition effect and demonstrates how momentum is generated under this model.

Analysis of the models predicts a number of relationships not previously reported, including a negative relationship between momentum returns and the market and a temporary reduction in market beta for positive momentum equities. We provide empirical evidence of these relationships in market data, consistent with the hypothesis that the disposition effect is influences investor behaviour.

Keywords: Momentum, Disposition, Behavioural, Equities

JEL Classification: G02, G11, G12