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A Rational Foundation for Trend-Chasing and Contrarian Trades with Implications for Momentum Anomalies

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  • Haim Kedar-Levy

    (The Guilford Glazer School of Business and Management, Ben-Gurion University of the Negev, and Ono Academic College, Israel)

Abstract

Trend-chasing and Contrarian are well-documented empirical trading patterns that the literature generally attributes to behavioral biases. In contrast, we argue that both are rational portfolio rebalancing strategies in a dynamic asset allocation framework. Analyzing the interactions between strategies implemented in stocks and bonds, we find that a key parameter is the investor's level of relative-risk-aversion versus the market price of risk. Our mapping of preferences to trades fits remarkably well recent empirical findings of time-series momentum and reversal. Specifically, speculators trade like Trend-chasers throughout the momentum phase closing positions once the trend reverses, while hedgers trade like Contrarians. These trades seem to explain time-series momentum.

Suggested Citation

  • Haim Kedar-Levy, 2013. "A Rational Foundation for Trend-Chasing and Contrarian Trades with Implications for Momentum Anomalies," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 3(01), pages 1-21.
    • Handle: RePEc:wsi:qjfxxx:v:03:y:2013:i:01:n:s2010139213500031
    DOI: 10.1142/S2010139213500031
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    References listed on IDEAS

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    1. Josef Lakonishok & Inmoo Lee & Allen M. Poteshman, 2004. "Investor Behavior in the Option Market," NBER Working Papers 10264, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Elroi Hadad & Haim Kedar-Levy, 2022. "The Impact of Retail Investors Sentiment on Conditional Volatility of Stocks and Bonds," Papers 2208.01538, arXiv.org.

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