BAFI Research Seminar

Momentum profits vary substantially across different market states. Motivated by this phenomenon, I develop a model to connect market states and momentum profits, and test the model’s empirical implications. The model applies the mechanism of overconfidence and self-attribution bias into a setting of multiple risky assets with correlated payoffs. A novel insight from the model is that overconfidence can vary asymmetrically between winners and losers, which leads to asymmetric return behaviors between winners and losers. The model generates a set of implications regarding the relation between market states and returns on the winner, loser, and momentum portfolios. These implications are consistent with empirical patterns in the literature and those newly documented in this paper. A calibration exercise shows that the model can match key empirical patterns with reasonable parameters. Overall, this paper unifies momentum, negative momentum profits under certain market states, and long-run reversals.

Contact Information:
Tedda Nathan
Dept. Administrator
txn2@case.edu
216.368.2040
216.368.6249