Behavioral Finance Economics 437 Behavioral Finance Momentum Apr

Behavioral Finance Economics 437 Behavioral Finance Momentum Apr 13, 2017

General Theme: Predictability n Fama French: “Cross Section” Article n Book/Market and Size => Stock Returns n “Value Investing” or “Contrarian Investing” n De. Bondt Thaler: “Over Reaction” n Buy past losers; Sell past winners n Value? Investing; Contrarian Investing n Jegadeesh Titman: “Price Momentum” n Possibly “Earnings Momentum” Behavioral Finance Momentum Apr 13, 2017

Ball & Brown 1986 n Market “underreacts” to earnings surprises n Article generally ignored until Jagdeesh- Titman n Time span suggests that Ball-Brown effect may be the same thing as Jagdeesh-Titman Behavioral Finance Momentum Apr 13, 2017

Jegadeesh and Titman (1993) n Relative strength strategies, sometimes called n n n “earnings momentum” strategies Find past winners and past losers (using 3 to 12 month holding periods) generate gains (winners gain; losers lose) Construct W portfolio and L portfolio W-L (using 6 month periods) earns more than 12 % better than market portfolio Longer term portfolios do best in next 12 months Interpretation in “event time” Doesn’t work in January Behavioral Finance Momentum Apr 13, 2017

Chan, Jegadeesh, Lakonishok 1996 n Is it earnings? Is it price? n They 7. 7 percent six month gap between winner portfolios and loser portfolios using price momentum. n Conclusion (page 1709): “ In general, the price momentum effect tends to be stronger and longer-lived than the earnings momentum effect. ” Behavioral Finance Momentum Apr 13, 2017

Chordia-Shivakumar, 2006 n Is it “pricing momentum” or “earnings momentum” that drives the “under-reaction” phenomenon? n Conclude the earnings momentum is the key factor. n Price momentum variables are a “noisy proxy” for earnings momentum Behavioral Finance Momentum Apr 13, 2017

Hong, Lee & Swaminathan 2003 n Earnings Momentum is the real driver of price momentum n Systematic relationship between earnings momentum and future GDP growth – hence a “risk factor” n This matters, because if there is a risk factor, then momentum might be consistent with EMH (which price momentum generally is not) Behavioral Finance Momentum Apr 13, 2017

Later Research on Predictability n For good summaries of the literature, read Haugen-Baker and Lakonishok, Vishny and Shleifer introductions Behavioral Finance Momentum Apr 13, 2017

Begin with Haugen-Baker 1996 n Their introduction is an excellent summary of the pros and cons of the “predictability” literature n Their empirical works is supportive of Fama-French n De. Bondt-Thaler n Jegadeesh-Titman n Behavioral Finance Momentum Apr 13, 2017

Now the Critics: n Conrad and Kaul, 1993 (data 1926 -1988) “We show that the returns to the typical long-term contrarian strategy…are upwardly biased because they are calculated by cumulating single-period (monthly) returns over long intervals” n Returns from ”buy and hold” strategies: (-1. 7 percent) n Ball, Kothari, Shanken 1995 n n “We document problems in measuring raw and abnormal five year contrarian portfolio returns. Their 163 percent mean return is due largely to their lowest-price quartile position…. . A contrarian portfolio formed at June-end earns negative abnormal returns, in contrast with the December-end portfolio. ” Behavioral Finance Momentum Apr 13, 2017

Welch and Goyal, 2008 n “We find that, by and large, these models have predicted poorly both in-sample and outof-sample for 30 years now; these models seem unstable, as diagnosed by their out-ofsample predictions and other statistics; and these models would not have helped an investor with access only to available information to profitably time the market. ” Behavioral Finance Momentum Apr 13, 2017

Lakonishov, Shleifer, Vishny, 1994 n Questions: Do value stocks really beat out growth stocks (the F-F issue revisited)? Growth based on earnings growth, etc. n Are value stocks actually riskier n Is there a reason that value stocks do better? n Answers: n Yes, by 10 – 11 percent annually n No, they outperform is all periods n Yes, future earnings of value stocks are better than predictions – opposite for growth stocks n Behavioral Finance Momentum Apr 13, 2017

The End Behavioral Finance Momentum Apr 13, 2017