Contrarians, Extrapolators, and Stock Market Momentum and Reversal

66 Pages Posted: 7 Dec 2020 Last revised: 8 Jan 2023

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

Mitchell E. Daniels, Jr School of Business, Purdue University; Purdue University - Krannert School of Management

Fangcheng Ruan

Purdue University - Krannert School of Management

Date Written: December 21, 2022

Abstract

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

Atmaz, Adem and Cassella, Stefano and Gulen, Huseyin and Ruan, Fangcheng, Contrarians, Extrapolators, and Stock Market Momentum and Reversal (December 21, 2022). 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

Mitchell E. Daniels, Jr School of Business, Purdue University ( email )

403 Mitch Daniels Blvd.
West Lafayette, IN 47907
United States

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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