A Rational Foundation for Trend-Chasing and Contrarian Trades with Implications for Momentum Anomalies

Haim Kedar-Levy ()
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Haim Kedar-Levy: The Guilford Glazer School of Business and Management, Ben-Gurion University of the Negev, and Ono Academic College, Israel

Quarterly Journal of Finance (QJF), 2013, vol. 03, issue 01, 1-21

Abstract: Trend-chasing and Contrarian are well-documented empirical trading patterns that the literature generally attributes to behavioral biases. In contrast, we argue that both are rational portfolio rebalancing strategies in a dynamic asset allocation framework. Analyzing the interactions between strategies implemented in stocks and bonds, we find that a key parameter is the investor's level of relative-risk-aversion versus the market price of risk. Our mapping of preferences to trades fits remarkably well recent empirical findings of time-series momentum and reversal. Specifically, speculators trade like Trend-chasers throughout the momentum phase closing positions once the trend reverses, while hedgers trade like Contrarians. These trades seem to explain time-series momentum.

Keywords: Trend-chasing; Contrarian; momentum; reversal; rational (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (2)

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DOI: 10.1142/S2010139213500031

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