An Institutional Theory of Momentum and Reversal

Dimitri Vayanos and Paul Woolley

No 14523, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We propose a rational theory of momentum and reversal based on delegated portfolio management. An investor can hold assets through an index or an active fund. Investing in the active fund involves a time-varying cost, interpreted as managerial perk or ability. The investor responds to an increase in the cost by flowing out of the active and into the index fund. While prices of assets held by the active fund drop in anticipation of these outflows, the drop is expected to continue, leading to momentum. Because outflows push prices below fundamental values, expected returns eventually rise, leading to reversal. Besides momentum and reversal, fund flows generate comovement, lead-lag effects and amplification, with all effects being larger for assets with high idiosyncratic risk. The active-fund manager's concern with commercial risk makes prices more volatile.

JEL-codes: D5 D8 G1 (search for similar items in EconPapers)
Date: 2008-12
New Economics Papers: this item is included in nep-rmg
Note: AP
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Citations: View citations in EconPapers (17)

Published as Dimitri Vayanos & Paul Woolley, 2013. "An Institutional Theory of Momentum and Reversal," Review of Financial Studies, Society for Financial Studies, vol. 26(5), pages 1087-1145.

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Related works:
Journal Article: An Institutional Theory of Momentum and Reversal (2013)
Working Paper: An institutional theory of momentum and reversal (2011)
Working Paper: An institutional Theory of Momentum and Reversal (2011)
Working Paper: An Institutional Theory of Momentum and Reversal (2008)
Working Paper: An Institutional Theory of Momentum and Reversal (2008)
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