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Information Percolation, Momentum, and Reversal

Author

Listed:
  • Julien Cujean

    (Robert H. Smith School of Business)

  • Daniel Andrei

    (UCLA Anderson)

Abstract

We propose a rational model to explain time-series momentum. The key ingredient is word-of-mouth communication, which we introduce in a noisy rational expectations framework. Word-of-mouth communication accelerates information revelation through prices and generates short-term momentum and long-term reversal. Social interactions allow investors with heterogeneous trading strategies—contrarian and momentum traders—to coexist in the marketplace. As a result, momentum is not completely eliminated, although a significant proportion of investors trade on it. We also show that word-of-mouth communication spreads rumors and generates price run-ups and reversals. Our theoretical predictions are in line with several empirical findings.

Suggested Citation

  • Julien Cujean & Daniel Andrei, 2016. "Information Percolation, Momentum, and Reversal," 2016 Meeting Papers 431, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:431
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    References listed on IDEAS

    as
    1. Craig W. Holden & Avanidhar Subrahmanyam, 2002. "News Events, Information Acquisition, and Serial Correlation," The Journal of Business, University of Chicago Press, vol. 75(1), pages 1-32, January.
    2. He, Hua & Wang, Jiang, 1995. "Differential Information and Dynamic Behavior of Stock Trading Volume," The Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 919-972.
    3. Admati, Anat R, 1985. "A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets," Econometrica, Econometric Society, vol. 53(3), pages 629-657, May.
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    Cited by:

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    2. Cerezo Sánchez, David, 2018. "The Valuation of Secrecy and the Privacy Multiplier," MPRA Paper 83954, University Library of Munich, Germany.

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