Contrarians, Extrapolators, and Stock Market Momentum and Reversal
66 Pages Posted: 7 Dec 2020 Last revised: 8 Jan 2023
Date Written: December 21, 2022
We document considerable cross-investor variation in survey expectations about aggregate stock market returns. While most investors are extrapolators who expect higher returns after a good market performance, some are contrarians who expect lower returns after a good performance. More notably, compared to extrapolators, contrarians have less persistent expectations that are corrected more quickly. We then develop a dynamic equilibrium model accounting for these differences in expectations and find that the equilibrium stock price exhibits short-term momentum and long-term reversal as in the data. Furthermore, we test the key predictions of our model linking the observable differences in extrapolators’ and contrarians’ expectations to stock market momentum and future stock performance, and find supportive evidence for our model mechanism.
Keywords: Extrapolative expectations, extrapolators, autocorrelation, momentum, reversal
JEL Classification: G11, G12
Suggested Citation: Suggested Citation