Momentum effect in individual stocks and heterogeneous beliefs among fundamentalists

Sandrine Jacob Leal

No 1203, Cahiers du CEREFIGE from CEREFIGE (Centre Europeen de Recherche en Economie Financiere et Gestion des Entreprises), Universite de Lorraine

Abstract: This paper investigates whether the observed “momentum effect” in individual stocks, caused by positive serial correlations in returns over short horizons, can be explained by fundamentalists’ heterogeneous beliefs when chartists are present in the market. For this purpose, we propose a heterogeneous agent model wherein agents follow different strategies and where information about asset fundamentals diffuses slowly. Computer-based simulations reveal that the interplay of fundamentalists and chartists can robustly generate positive serial correlations in returns over short horizons. Especially, short-term momentum is explained by trend-following strategies and slow diffusion of information. Furthermore, our model is able to simultaneously generate the momentum effect in individual stock returns, asset price overreaction and misalignments often observed in real financial time series.

Keywords: momentum effect; return predictability; bounded rationality; trading strategies; computer-based simulations (search for similar items in EconPapers)
Pages: 16 pages
Date: 2012, Revised 2012
New Economics Papers: this item is included in nep-cmp and nep-cwa
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