Journal of Financial Economics Vol. 123 No. 3 2017
Information percolation, momentum and reversal
Abstract
We propose a joint theory of time-series momentum and reversal based on a rational-expectations model. We show that a necessary condition for momentum to arise in this framework is that information flows at an increasing rate. We focus on word-of-mouth communication as a mechanism that enforces this condition and generates short-term momentum and long-term reversal. Investors with heterogeneous trading strategies—contrarian and momentum traders—coexist in the marketplace. Although a significant proportion of investors are momentum traders, momentum is not completely eliminated. Word-of-mouth communication spreads rumors and generates price run-ups and reversals. Our theoretical predictions are in line with empirical findings.
- DOI
- 10.1016/j.jfineco.2016.05.012
- Volume
- 123
- Issue
- 3
- Pages
- 617-645
- Language
- en
- Sources
- bibtex:phds-export.bib crossref openalex