Cognitive dissonance, sentiment and momentum
Antoniou, Constantinos; Doukas, John A.; Subrahmanyam, Avanidhar
Date: 29 November 2012
Journal
Journal of Financial and Quantitative Analysis
Publisher
Cambridge University Press
Publisher DOI
Abstract
We consider whether sentiment affects the profitability of momentum strategies. We hypothesize that news that contradicts investors' sentiment causes cognitive dissonance, slowing the diffusion of such news. Thus, losers (winners) become underpriced under optimism (pessimism). Short-selling constraints may impede arbitraging of losers ...
We consider whether sentiment affects the profitability of momentum strategies. We hypothesize that news that contradicts investors' sentiment causes cognitive dissonance, slowing the diffusion of such news. Thus, losers (winners) become underpriced under optimism (pessimism). Short-selling constraints may impede arbitraging of losers and thus strengthen momentum during optimistic periods. Supporting this notion, we empirically show that momentum profits arise only under optimism. An analysis of net order flows from small and large trades indicates that small investors are slow to sell losers during optimistic periods. Momentum based hedge portfolios formed during optimistic periods experience long-run reversals.
Finance and Accounting
Faculty of Environment, Science and Economy
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