Short-Term Reversals, Short-Term Momentum, and News-Driven Trading Activity

Abstract

We find no evidence of monthly return reversals for the top quintile of small- and large-cap stocks ranked by turnover. Indeed, stocks in the top decile of turnover display short-term momentum. We argue these findings arise from a combination of effects. First, short-term reversals stem from short-term liquidity demands. Second, news-driven returns tend to continue rather than reverse. Third, turnover acts as a proxy for both liquidity and news-driven trading activity. The evidence suggests that reversals give way to momentum as turnover increases because high-turnover stocks are more liquid than low-turnover stocks and their returns are more reflective of news-driven trading activity. For example, the correlation between the monthly returns of stocks that announce earnings during the month and their announcement-window returns increases with monthly turnover. Furthermore, sorting stocks into turnover-based portfolios that are rebalanced monthly leads to a disproportionate number of stocks with earnings announcements in the high-turnover portfolios.

Keywords: turnover, information diffusion, liquidity, return continuations, post earnings announcement drift, cross-section of expected returns

JEL Classification: G12