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Momentum and Reversal in Financial Markets with Persistent Heterogeneity

Author

Listed:
  • Giulio Bottazzi

    () (Department of Economics, Scuola Superiore Sant'Anna, Pisa)

  • Pietro Dindo

    () (Department of Economics, University Of Venice Cà Foscari)

  • Daniele Giachini

    (Department of Economics, Scuola Superiore Sant'Anna, Pisa)

Abstract

This paper investigates whether short-term momentum and long-term reversal may emerge from the wealth reallocation process taking place in speculative markets. We assume that there are two classes of investors who trade long-lived assets by holding constantly rebalanced portfolios based on their beliefs. Provided beliefs, and thus portfolios, are sufficiently diversified, all investors survive in the long-run and, due to waves of mispricing, the resulting equilibrium returns exhibit long-term reversal. If, moreover, asset dividends are positively correlated, investors’ profitable trades become positively correlated too, thus generating short-term momentum in equilibrium returns. We use the model to replicate the performance of the Winners and Losers portfolios highlighted by the empirical literature and to provide insights on how to improve upon them. Finally, we show that dividend positive autocorrelation is positively related to momentum and negatively related to reversal while diversity of beliefs is positively related to both momentum and reversal.

Suggested Citation

  • Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2018. "Momentum and Reversal in Financial Markets with Persistent Heterogeneity," Working Papers 2018:03, Department of Economics, University of Venice "Ca' Foscari".
  • Handle: RePEc:ven:wpaper:2018:03
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    Cited by:

    1. Dindo, Pietro, 2019. "Survival in speculative markets," Journal of Economic Theory, Elsevier, vol. 181(C), pages 1-43.
    2. Daniele Giachini, 2018. "Rationality and Asset Prices under Belief Heterogeneity," LEM Papers Series 2018/07, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    3. Daniele Giachini, 2021. "Rationality and asset prices under belief heterogeneity," Journal of Evolutionary Economics, Springer, vol. 31(1), pages 207-233, January.

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    More about this item

    Keywords

    Market Efficiency; Heterogeneous Beliefs; Speculation; Short-term Momentum; Long-term Reversal;
    All these keywords.

    JEL classification:

    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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