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Short-Term Momentum and Reversals in Large Stocks: Dynamic Market Trends

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Short-Term Momentum and Reversals in Large Stocks” by Jason Zhanshun Wei and Liyan Yang explores the coexistence of momentum and reversals among large-cap stocks over a holding period of up to six months.

Utilizing data from stocks traded on the NYSE, AMEX, and NASDAQ between 1964 and 2009, the study finds that while momentum predominates among small-cap stocks, large-cap/low-volatility stocks display reversals and large-cap/high-volatility stocks exhibit momentum. This finding contrasts significantly with existing literature on the subject, which typically documents and explains momentum and reversals across differing time horizons.

The authors’ results both contribute novel empirical evidence regarding the cross-sectional return predictability and challenge existing theoretical paradigms. Furthermore, they provide insights into why large stocks generally demonstrate no or weak short-term momentum and propose a theoretical model based on “moderated confidence” to rationalize simultaneous underreaction and overreaction among investors.

Abstract Of Paper

Using stocks traded on the NYSE, AMEX and NASDAQ for the period of 1964 to 2009, this study demonstrates that, while momentum prevails among small stocks, momentum and reversals coexist among large stocks for a holding period of up to six months. The momentum/reversal divide is along the volatility dimension: Large-cap/low-volatility stocks exhibit reversals while large-cap/high-volatility stocks experience momentum. Our finding is in sharp contrast with those in the existing literature which mostly documents and explains momentum and reversals for different horizons. As such, our study not only offers fresh, new empirical findings on cross-section return predictability but also poses a challenge to the existing theoretical paradigms that are tailored to sequential occurrence of momentum and reversals. Specifically, we contribute to the literature by 1) uncovering a new empirical regularity which explains why large stocks are generally associated with no or weak momentum in the short-term, and 2) advancing a theoretical model based on “moderated confidence” which can rationalize empirical findings such as the one in the current paper where underreaction and overreaction can occur simultaneously with the same investor.

Original paper – Download PDF

Here you can download the PDF and original paper of Short-Term Momentum and Reversals in Large Stocks.

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Author

Jason Zhanshun Wei
University of Toronto – Rotman School of Management

Liyan Yang
University of Toronto – Rotman School of Management

Conclusion

In conclusion, the study “Short-Term Momentum and Reversals in Large Stocks” by Jason Zhanshun Wei and Liyan Yang offers valuable insights into the coexistence of momentum and reversals in large-cap stocks over a holding period of up to six months.

By analyzing data from the period of 1964 to 2009, the authors find a momentum/reversal divide with large-cap/low-volatility stocks demonstrating reversals and large-cap/high-volatility stocks exhibiting momentum. Their findings not only present fresh empirical evidence on cross-sectional return predictability, but also challenge traditional theoretical paradigms that predominantly focus on the sequential occurrence of momentum and reversals.

The authors further contribute by revealing new empirical regularities that explain the generally weak short-term momentum in large stocks and by proposing a “moderated confidence” model that can rationalize the simultaneous occurrence of underreaction and overreaction among investors.

Related Reading:

Do Momentum and Reversals Coexist?

Abnormal Trading Volume and the Cross-Section of Stock Returns

FAQ

Q1: What is the main focus of the research paper, and what novel findings does it present regarding the behavior of large-cap stocks over a short-term holding period?

The research paper investigates the coexistence of momentum and reversals in large-cap stocks over a holding period of up to six months. It introduces a unique empirical finding that diverges from existing literature, revealing that large-cap/low-volatility stocks display reversals, while large-cap/high-volatility stocks exhibit momentum.

Q2: How does the study contribute to the understanding of cross-sectional return predictability, and what challenge does it pose to existing theoretical paradigms?

The study contributes novel empirical evidence on cross-sectional return predictability by challenging the traditional view that momentum and reversals occur sequentially. The findings challenge existing theoretical paradigms that primarily focus on the sequential occurrence of momentum and reversals, presenting a new perspective on the simultaneous coexistence of these phenomena in the stock market.

Q3: What additional insights does the research offer, particularly regarding the behavior of large stocks in the short term, and what theoretical model is proposed to rationalize the observed empirical findings?

The study provides insights into why large stocks generally demonstrate no or weak short-term momentum. It introduces a theoretical model based on “moderated confidence” to rationalize the simultaneous occurrence of underreaction and overreaction among investors, offering a theoretical framework to explain the observed empirical regularities in the behavior of large-cap stocks.

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