An explanation for momentum with a rational model under symmetric information – Evidence from cross country equity markets

Christian Koziol and Juliane Proelss

Journal of International Financial Markets, Institutions and Money, 2021, vol. 70, issue C

Abstract: In this paper, we show that momentum patterns in equity returns can arise even in a parsimonious model with rational investors having symmetric information. The special feature of our model is that investors obtain a signal before observing the true asset payoff. A more favorable signal, however, impacts both the standard deviation of the return and its skewness. Since investors under rational expectations account for the current risk properties of the asset, the risk-adjusted subsequent return is related to the signal and therefore to the previous asset return. Hence, momentum does not need to be an anomaly but can be consistent with informational market efficiency where a higher subsequent return comes from a higher standard deviation of the asset return and/or a more severe negative skewness. Due to this rationale, it can be present in the future even though investors will have no incentive to exploit it. We test our approach on ten different equity markets, focussing on U.S. and China which are known to be dominated by different types of investors. The structure of the model allows us to identify for which type of investor momentum pattern is especially likely. The cross country analysis with equity markets characterized by different degrees of risk aversion reveals that risk aversion is a crucial driver for momentum. If risk aversion is more severe, momentum effects are more pronounced.

Keywords: Reason for momentum; Market efficiency; Rational representative investor; Lognormal distribution; Time series momentum; Risk aversion; Cross-country evidence (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:70:y:2021:i:c:s1042443120301426

DOI: 10.1016/j.intfin.2020.101258

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