The Disposition Effect and Momentum
We examine how the disposition effect, an empirically documented bias in investor behavior, affects market prices. We show that the disposition effect can help explain positive autocorrelation of returns, i.e. the momentum effect. Our model explains the strong seasonality in momentum profits and is consistent with other empirical regularities of momentum profits. In contrast to other recent work, our momentum result does not rely on biases in the expectation of fundamentals. It is consequently independent of whether price changes are driven by news about fundamentals or something else (price bubbles, noise) and it is consistent with prices over- or underreacting to news about fundamentals.
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|Date of creation:||09 May 2001|
|Date of revision:|
|Note:||We are grateful for research support from the Deutsche Forschungsgemeinschaft through Sonderforschungsbereich 504 and the Graduiertenkolleg ''Allocation on Financial Markets'' at the University of Mannheim, and by the European Commission through the Research Training Network ''Understanding Financial Architecture'' at the University of Toulouse. We would like to thank Ulrich Hege and Frederic Palomino who discussed this paper at conferences.|
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