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The Disposition Effect and Momentum

Heiko Zuchel () and Martin Weber
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Heiko Zuchel: Universität Mannheim, Graduiertenkolleg Allokation auf Finanz- und Gütermärkten, Postal: D-68131 Mannheim

No 01-26, Sonderforschungsbereich 504 Publications from Sonderforschungsbereich 504, Universität Mannheim, Sonderforschungsbereich 504, University of Mannheim

Abstract: We examine how the disposition effect, an empirically documented bias in investor behavior, affects market prices. We show that the disposition effect can help explain positive autocorrelation of returns, i.e. the momentum effect. Our model explains the strong seasonality in momentum profits and is consistent with other empirical regularities of momentum profits. In contrast to other recent work, our momentum result does not rely on biases in the expectation of fundamentals. It is consequently independent of whether price changes are driven by news about fundamentals or something else (price bubbles, noise) and it is consistent with prices over- or underreacting to news about fundamentals.

Date: 2001-05-09
Note: We are grateful for research support from the Deutsche Forschungsgemeinschaft through Sonderforschungsbereich 504 and the Graduiertenkolleg ''Allocation on Financial Markets'' at the University of Mannheim, and by the European Commission through the Research Training Network ''Understanding Financial Architecture'' at the University of Toulouse. We would like to thank Ulrich Hege and Frederic Palomino who discussed this paper at conferences.
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