Momentum and Reversals When Overconfident Investors Underestimate Their Competition. (15th February 2020)

• Record Type: Journal Article
• Authors: Luo, Jiang; Subrahmanyam, Avanidhar; Titman, Sheridan
• Editors: Goldstein, Itay
• Is Part Of: Review of financial studies. Volume 34:Number 1(2021)
• Page Start: 351
• Page End: 393
• Publication Date: 2020-02-15
• Subjects: G12 -- G14 -- G41; Finance -- United States -- Periodicals; Finance -- Periodicals; 332
• DOI: 10.1093/rfs/hhaa016
• Languages: English
• ISSNs: 0893-9454

Abstract

Abstract: We develop a model in which overconfident investors overestimate their own signal quality but are skeptical of others' Investors who are initially uninformed believe that early-informed investors have learned little, leading the former investors to provide excess liquidity, which, in turn, causes underreaction and short-run momentum. Skeptical investors can also react to stale information, causing momentum, followed by reversals. Hence, skepticism generates both momentum and reversals; the latter are amplified if investors overassess their own signal precision. We explain how long-run reversals can disappear while shorter-term momentum prevails, provide empirical implications, and link momentum to liquidity and price efficiency.