An Institutional Theory of Momentum and Reversal

Dimitri Vayanos and Paul Woolley

No 7068, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We propose a rational theory of momentum and reversal based on delegated portfolio management. A competitive investor can invest through an index fund or an active fund run by a manager with unknown ability. Following a negative cashflow shock to assets held by the active fund, the investor updates negatively about the manager's ability and migrates to the index fund. While prices of assets held by the active fund drop in anticipation of the investor's outflows, the drop is expected to continue, leading to momentum. Because outflows push prices below fundamental values, expected returns eventually rise, leading to reversal. Fund flows generate comovement and lead-lag effects, with predictability being stronger for assets with high idiosyncratic risk. We derive explicit solutions for asset prices, within a continuous-time normal-linear equilibrium.

Keywords: Delegated portfolio management; Limits to arbitrage; Momentum; Reversal (search for similar items in EconPapers)
JEL-codes: D5 D8 G1 (search for similar items in EconPapers)
Date: 2008-12
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

Downloads: (external link)
https://cepr.org/publications/DP7068 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

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)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:7068

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP7068

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().