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Cognitive Dissonance, Sentiment, and Momentum

Published online by Cambridge University Press:  29 November 2012

Constantinos Antoniou ,
John A. Doukas  and
Avanidhar Subrahmanyam
Constantinos Antoniou
Affiliation:
[email protected], Xfi Centre for Finance and Investment, University of Exeter Business School, Streatham Court, Rennes Dr, Exeter, EX4 4ST, UK
John A. Doukas
Affiliation:
[email protected], Old Dominion University Graduate School of Business, Constant Hall Ste 2080, Norfolk, VA 23529, and Judge Business School, University of Cambridge
Avanidhar Subrahmanyam
Affiliation:
[email protected], Anderson School of Management, University of California at Los Angeles, 110 Westwood Plz, Los Angeles, CA 90095.
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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 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.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 48 , Issue 1 , February 2013 , pp. 245 - 275
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2013 

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