Different Extrapolators and Stock Market Momentum and Reversal
47 Pages Posted: 7 Dec 2020
Date Written: October 31, 2020
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: Suggested Citation