Summary
We show that information diffusion is a function of its dissemination and assimilation. Whereas dissemniation is a function of observable factors such as volume and price volatility, assimilation is dependent on unobservable factors such as the usefulness and reliability of information. We find that buying low volume (or low volatility) past losers and shortselling low volume (or low volatility) past winners generates a positive net return across the entire sample period and especially during bear markets. Second, buying high volatility past winners and shortselling high volatility past losers generates a positive net return, especially during bear markets.
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Extract
Explaining Momentum Profits with an Epidemic Diffusion Model
Introduction
Over the past several years, a large volume of empirical work has documented a variety of anomalous return patterns which are difficult to explain from the perspective of the Efficient Market Hypothesis (EMH). In particular, several recent papers have documented that stock returns are positively correlated at lags of three to twelve months and display a negative autocorrelation at horizons of one to five years. Return patterns tend to exhibit momentum in the short run, with past winners continuing to perform well, and past losers continuing to perform poorly. For example, Jegadeesh and Titman (1993) find that a strategy that buys stocks that have performed in the highest decile over the past six months and simultaneously sells short stocks in the lowest decile over the same time period earns a positive momentum net profit over the next six to twelve months. Rouwenhorst (1998) finds a similar pattern of intermediate-term price momentum in twelve other countries, suggesting that the results are not due to a data mining bias. Few explanations have been offered for this intermediate-term momentum effect. For example, Fama and French (1996) show that a three-factor model of returns fails to explain intermediate-term price momentum. More recently. Conrad and Kaul (1998) suggest that the cross-sectional variation in the mean returns of individual securities might account for the momentum effect. Similarly, Moskowitz and Grinblatt (1999) theorize that a significant component of firm-specific momentum can be explained by industry momentum. However, Grundy and Martin (2001) show that momentum effects are not explained by cross-sectional variations in expected returns or industry effects.Other research shows that return patterns have a tendency ...See the full content of this document
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