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Momentum and Reversal in Financial Markets with Persistent Heterogeneity

Author

Listed:
  • Giulio Bottazzi
  • Pietro Dindo
  • Daniele Giachini
Abstract
This paper investigates whether short-term momentum and long-term reversal may emerge from the wealth reallocation process taking place in speculative markets. We assume that there are two classes of investors who trade long-lived assets by holding constantly rebalanced portfolios based on their beliefs. Provided beliefs, and thus portfolios, are sufficiently diversified, all investors survive in the long-run and, due to waves of mispricing, the resulting equilibrium returns exhibit long-term reversal. If, moreover, asset dividends are positively correlated, investors' profitable trades become positively correlated too, thus generating short-term momentum in equilibrium returns. We use the model to replicate the performance of the Winners and Losers portfolios highlighted by the empirical literature and to provide insights on how to improve upon them. Finally, we show that dividend positive autocorrelation is positively related to momentum and negatively related to reversal while diversity of beliefs is positively related to both momentum and reversal.

Suggested Citation

  • Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2018. "Momentum and Reversal in Financial Markets with Persistent Heterogeneity," LEM Papers Series 2018/04, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
  • Handle: RePEc:ssa:lemwps:2018/04
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    Cited by:

    1. Giulio Bottazzi & Daniele Giachini, 2022. "Strategically Biased Learning In Market Interactions," Advances in Complex Systems (ACS), World Scientific Publishing Co. Pte. Ltd., vol. 25(02n03), pages 1-18, March.
    2. Bottazzi, Giulio & Giachini, Daniele & Ottaviani, Matteo, 2023. "Market selection and learning under model misspecification," Journal of Economic Dynamics and Control, Elsevier, vol. 156(C).
    3. Dindo, Pietro, 2019. "Survival in speculative markets," Journal of Economic Theory, Elsevier, vol. 181(C), pages 1-43.
    4. Bottazzi, Giulio & Giachini, Daniele, 2022. "A general equilibrium model of investor sentiment," Economics Letters, Elsevier, vol. 218(C).
    5. Daniele Giachini, 2018. "Rationality and Asset Prices under Belief Heterogeneity," LEM Papers Series 2018/07, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    6. Rabah Amir & Sergei Belkov & Igor V. Evstigneev & Thorsten Hens, 2022. "An evolutionary finance model with short selling and endogenous asset supply," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 73(2), pages 655-677, April.
    7. Mohamed Sahbi Nakhli & Abderrazak Dhaoui & Julien Chevallier, 2022. "Bootstrap rolling-window Granger causality dynamics between momentum and sentiment: implications for investors," Annals of Finance, Springer, vol. 18(2), pages 267-283, June.
    8. Daniele Giachini, 2021. "Rationality and asset prices under belief heterogeneity," Journal of Evolutionary Economics, Springer, vol. 31(1), pages 207-233, January.
    9. Andrea Antico & Giulio Bottazzi & Daniele Giachini, 2024. "Pricing anomalies in a general equilibrium model with biased learning," LEM Papers Series 2024/14, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    10. Andrea Antico & Giulio Bottazzi & Daniele Giachini, 2022. "On the evolutionary stability of the sentiment investor," LEM Papers Series 2022/09, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.

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    More about this item

    Keywords

    Market Efficiency; Heterogeneous Beliefs; Speculation; Short-term Momentum; Long-term Reversal;
    All these keywords.

    JEL classification:

    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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