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An institutional Theory of Momentum and Reversal

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  • Dimitri Vayanos
  • Paul Woolley

Abstract

We propose a rational theory of momentum and reversal based on delegated portfolio management. Flows between investment funds are triggered by changes in fund managers' e±ciency, which investors either observe directly or infer from past performance. Momentum arises if fund °ows exhibit inertia, and because rational prices do not fully adjust to re°ect future °ows. Reversal arises because °ows push prices away from fundamental values. Besides momentum and reversal, fund °ows generate comovement, lead-lag e®ects and ampli¯cation, with all e®ects being larger for assets with high idiosyncratic risk. Managers' concern with commercial risk can make prices more volatile.

Suggested Citation

  • Dimitri Vayanos & Paul Woolley, 2011. "An institutional Theory of Momentum and Reversal," FMG Discussion Papers dp666, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp666
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D5 - Microeconomics - - General Equilibrium and Disequilibrium
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G1 - Financial Economics - - General Financial Markets

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