1. Behavioral Finance Momentum March 26, 2015 Behavioral Finance Economics 437

2. Behavioral Finance Momentum Steve Ross (MIT) Creator of “Arbitrage Pricing Theory” Now researching “can you predict ‘expected returns’ from stock prices Will be here on April 17 th, 2015 Great lecturer – you should attend!!

3. Behavioral Finance Momentum Definition of absence of Momentum Let p t-1, p t-2, p t-3, etc. be a series of past prices Now, think about, p t E[ p t | info, p t-1, p t-2, p t-3, etc.] = E[ p t | info] Then, no Momentum

4. Behavioral Finance Momentum Trader Lore Stocks whose prices are in an “uptrend” will continue to go up (and likely do better than stocks with no trend or in a “downtrend”). Many investors “chart” stock prices in order to predict future stock prices This is called “technical research” in Wall Street lore Very widely used by professional money managers (watch CNBC from 5PM to 6PM any day of the week)

5. Behavioral Finance Momentum Ball and Brown, 1968 Interested in knowing if stock prices “anticipated” favorable and unfavorable earnings announcements. Have to define “unexpected” favorable and unfavorable. Regression to predict earnings from earnings of similar firms – differences represent “unexpected” favorable or unfavorable Found that “market begins to anticipate forecast errors early in the 12 months preceding the earnings report”…”and continue for approximately one month after.”

6. Behavioral Finance Momentum Jegadeesh & Titman, 1993 Under Reaction…Earnings or Price Momentum 3 to 12 months horizons (compared to 3 to 5 years in DeBondt-Thaler) In the trade, this is called “momentum” or “relative strength” Zero cost portfolio results 6 month/6 month yields 12 % per year return 12 month/ 3 month is best 1.31% per month

7. Behavioral Finance Momentum Chordia & Shivakumar, 2006 Is it “earnings” momentum or “price” momentum Page 655: “Our results support the argument that price momentum is primarily subsumed by the systematic component of earnings momentum and that price momentum is merely a manifestation of the earnings momentum.”

8. Behavioral Finance Momentum Leippold & Lohre, 2010 Look at non-US data Find price earnings momentum Agree generally with Chordia-Shivakumar But,”we provide additional evidence that international momentum strategies appear to be mostly limited to highly illiquid stocks.”

9. Behavioral Finance Momentum Sadka, 2005 “Role of Liquidity Risk” Conclusion: “the results suggest that a substantial part of momentum and PEAD (post-earnings- announcement drift) returns can be viewed as compensation of the unexpected variations in the aggregate ratio of informed traders to noise traders.” “Unexpected systematic variations of (the variable component of) liquidty are shown to be priced within the context of momentum and PEAD

10. Behavioral Finance Momentum The End