Memory-induced Cross-stock Extrapolation in China
62 Pages Posted: 10 Feb 2025 Last revised: 24 Mar 2025
Date Written: February 09, 2025
Abstract
We propose a similarity criterion for stocks based on their Euclidean distance over a set of attention-related variables to capture investors' memory of stocks. We find that the average past return of similar-attention stocks exhibits a significantly strong, negative predictive power for the future return of a focal stock, suggesting a cross-stock reversal effect. A long-short strategy based on this cross-stock reversal generates a monthly return of 2.23% and an annualized Sharpe ratio of 1.63. This effect cannot be explained by common factors, including short-term reversal. We further demonstrate that the cross-stock reversal effect stems from investors' memory-based belief and irrational cross-extrapolating trading. The predictability is related to the investor clientele since it appears in markets with more retail investors.
Keywords: Memory, Cross-stock predictability, Extrapolation, Reversal, Attention
JEL Classification: G11, G12, G14
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