Different Extrapolators and Stock Market Momentum and Reversal

47 Pages Posted: 7 Dec 2020

See all articles by Adem Atmaz

Adem Atmaz

Purdue University - Krannert School of Management

Stefano Cassella

Tilburg University- School of Economics and Management

Huseyin Gulen

Purdue University - Krannert School of Management

Fangcheng Ruan

Purdue University - Krannert School of Management

Date Written: October 31, 2020

Abstract

Using survey data, we document significant differences in investors' extrapolative expectations about future stock market returns. Namely, there are both negative and positive extrapolators. Compared to positive extrapolators, negative extrapolators are fewer in numbers but put relatively more weight on the recent stock returns when forming their expectations. Accordingly, we develop a dynamic equilibrium model that accounts for these differences in investors’ extrapolative expectations. In the model, the equilibrium stock price exhibits short-term momentum and long-term reversal as in the data. We also test the key predictions of the model and find supportive evidence for the model mechanism.

Keywords: Extrapolative expectations, negative extrapolators, autocorrelation, momentum, reversal

JEL Classification: G11, G12

Suggested Citation

Atmaz, Adem and Cassella, Stefano and Gulen, Huseyin and Ruan, Fangcheng, Different Extrapolators and Stock Market Momentum and Reversal (October 31, 2020). Available at SSRN: https://ssrn.com/abstract=3722540 or http://dx.doi.org/10.2139/ssrn.3722540

Adem Atmaz (Contact Author)

Purdue University - Krannert School of Management ( email )

403 West State Street
West Lafayette, IN 47907
United States

HOME PAGE: http://www.aatmaz.com

Stefano Cassella

Tilburg University- School of Economics and Management ( email )

Professor de Moorplein 521
Tilburg, 5037
Netherlands

Huseyin Gulen

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

Fangcheng Ruan

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

HOME PAGE: http://sites.google.com/view/ruanfangcheng/home

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