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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. Admati, Anat R, 1985. "A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets," Econometrica, Econometric Society, vol. 53(3), pages 629-657, May.
    2. 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.
    3. 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.
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    Cited by:

    1. Cerezo Sánchez, David, 2018. "The Valuation of Secrecy and the Privacy Multiplier," MPRA Paper 83954, University Library of Munich, Germany.
    2. Semih Üslü, 2019. "Pricing and Liquidity in Decentralized Asset Markets," Econometrica, Econometric Society, vol. 87(6), pages 2079-2140, November.

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