66 Pages Posted: 17 Apr 2018 Last revised: 8 Nov 2019
Date Written: October 30, 2019
We document a striking pattern in the cross section of U.S. and international stock returns: double sorting on the previous month's return and share turnover results in significant short-term reversal among low-turnover stocks whereas high-turnover stocks exhibit short-term momentum. Short-term momentum is as profitable and persistent as conventional momentum, is exclusively a large-cap phenomenon, and survives transaction costs. Using a tractable yet flexible model, we illustrate how our results are difficult to reconcile with rational expectations but are in line with inefficient use of the information conveyed by prices. We derive novel predictions about the effects of liquidity trading and the link to fundamentals for which we find supporting evidence.
The figure shows average returns to three strategies that buy the previous month’s winners and short the previous month’s losers: A conventional short-term reversal strategy; a short-term reversal* strategy that trades in low-turnover stocks; and a short-term momentum strategy that trades in high-turnover stocks.
Keywords: Momentum, Reversal, Cursed Expectations Equilibrium, Return Predictability
JEL Classification: G12, G14
Suggested Citation: Suggested Citation