Several recent papers have documented that, at medium-term horizons ranging from three to twelve months, stock returns exhibit momentum—i.e., past winners continue to perform well, and past losers continue to perform poorly. For example, Jegadeesh and Titman (1993), using a U.S. sample of NYSE/AMEX stocks over the period 1965-1989, find that a strategy that buys past six-month winners (stocks in the top performance decile) and shorts past six-month losers (stocks in the bottom performance decile) earns approximately one percent per month over the subsequent six months. Not only is this an economically interesting magnitude, but the result also appears to be robust: Rouwenhorst (1997a) obtains very similar numbers in a sample of 12 European countries over the period 1980-1995.
While the existence of a momentum effect in stock returns does not seem to be too controversial, it is much less clear what might be driving it. Some have suggested a risk-based interpretation of momentum.2 This is certainly a logical possibility, although there is little evidence that cuts clearly in favor of a risk story. In this vein, Fama and French (1996) note that momentum effects are not subsumed by their three-factor model. 24 hour payday loans
Turning to “behavioral” (i.e., non-risk-based) explanations, there are a number of theories that can give rise to positive medium-term return autocorrelations. In some of these, prices initially overreact to news about fundamentals, then continue to overreact further for a period of time. The positive-feedback-trader model of DeLong et al (1990) fits in this camp, as does the overconfidence model of Daniel, Hirshleifer and Subrahmanyam (1997). In other models, momentum is a symptom of underreaction—prices adjust too slowly to news.