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Understanding Behavioral Finance: Momentum and Liquidity in Economics

Explore the impact of behavioral finance on economics, analyzing momentum strategies like mean reversion and price momentum, along with factors such as liquidity and discount rates. Delve into research by Fama-French, DeBondt & Thaler, Jagadeesh & Titman, and more to understand market anomalies and investment strategies.

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Understanding Behavioral Finance: Momentum and Liquidity in Economics

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  1. Behavioral Finance Economics 437

  2. Announcements • Prof Burton speaking at noon at Farmington on Tuesday, April 22nd…. • Picnic at Prof Burton’s – Sunday, April 20th, near Foxfield, Noon to 3 PM • Next midterm is April 15th (Tuesday)

  3. So, where are we? • Fama-French, 1992 • Focus on BE/ME (and ME) • They conclude that there are unknown “risk” factors • Behavioralists conclude the EMH is false • DeBondt & Thaler, 1984 (“Mean Reversion”) • Based upon 5 year periods • Buy “losers” Sell “winners” • Earn 25 % net….mostly on the purchase of “losers” • Dubbed “overreaction” or “mean reversion” • Jagedeesh & Titman, 1993 (“Price” momentum) • 3 to 12 month periods • Buy “winners” Sell “losers • Average gain of “zero cost portfolio” is 1 % per month • Chordia & Shivumkar (Earnings momentum subsumes price momentum) • 9 percent per month • Negative January effect • Scott & Murillo “Rational Part of Momentum,” 2008 • “Informed investors” buy early • Prices “predict” future increases in fundamental value

  4. Sadka, “Momentum & Liquidity Risk,” 2006 • Central issue: Can you explain earnings and price momentum by “liquidity” • Less liquid stocks earn a “liquidity premium” • Liquidity is a “priced” factor • Biggest problem • Empirical definition of liquidity • Data mining potential

  5. Kothari, Lewellen & Warner: “Stock Returns, Aggregate Earnings Surprises, and Behavioral Finance • Does momentum hold in the “aggregate” • If not, somehow it is not as important, according to authors • Requires further explanation as to why aggregate behavior differs from “micro” behavior • Argues that changes in “discount rate” may be more important than “earnings surprises”

  6. End

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