Decoupling stock price momentum from accounting fundamentals

Irfan Safdar

Pacific Accounting Review, 2020, vol. 32, issue 4, 519-541

Abstract: Purpose - What explains patterns in stock prices is an important question. One such pattern, price momentum, is a well-known capital markets anomaly where recent stock price performance appears to continue into the future. This momentum is frequently thought to reflect delayed reaction by investors to unspecified information (i.e. underreaction). This study aims to provide a useful insight regarding momentum: potential mispricing related to accounting fundamentals appears to conceal longer-term reversals in price momentum. Controlling for these fundamentals reveals that price momentum reverses, indicating that investor overreaction is a potentially important source of stock price momentum. The evidence presented in this study emphasizes the importance of decoupling momentum and accounting fundamentals to achieve a more complete understanding of what explains stock price momentum. Design/methodology/approach - This study explores this question by examining the longer-term performance of momentum stocks in the US market after decoupling it from performance related to accounting fundamentals using returns to fundamentals-based factors as controls in time series regressions. Findings - This study finds evidence of clear reversals in the remaining price momentum. These reversals provide a new insight into the momentum effect because they imply that the component of price momentum not traceable to accounting fundamentals reflects investor overreaction rather than underreaction. Originality/value - The findings indicate that the underlying nature of the information driving price movements is important to achieving a complete understanding of what explains price momentum. To the best of the author’s knowledge, no other study has examined the behavior of stock price momentum while controlling for accounting fundamentals.

Keywords: Capital markets; Accounting fundamentals; Stock price momentum (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eme:parpps:par-01-2020-0011

DOI: 10.1108/PAR-01-2020-0011

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