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Sandrine Jacob Leal
 
''Momentum effect in individual stocks and heterogeneous beliefs among fundamentalists''
( 2013, Vol. 33 No.4 )
 
 
This paper investigates whether the observed momentum effect in individual stocks, caused by positive serial correlations in monthly returns over short horizons, can be explained by fundamentalists' heterogeneous beliefs when chartists are present in the market. To this end, we propose a heterogeneous agent model wherein agents follow different strategies and information about asset fundamentals diffuses slowly. On the one hand, fundamentalists predict future prices based on the observed discrepancy between the current stock price and its fundamental value. However, due to slow diffusion of firm-specific information, fundamentalists have heterogeneous beliefs about asset fundamentals. On the other hand, chartists predict future prices based on the observation of past price movements. Computer-based simulations reveal that the interplay of fundamentalists and chartists can robustly generate positive serial correlations in monthly returns over short horizons, stock price overreaction to news events and price misalignments. In particular, we find that (i.) slow diffusion of information does not suffice to explain the momentum effect in individual stocks; (ii.) the interplay of fundamentalists and chartists robustly generates short-term momentum in returns, which is mainly driven by the pervasive presence of chartists; (iii.) we find that, when trend followers dominate the market, stock price overreacts and subsequently corrects due to slow diffusion of firm-specific information.
 
 
Keywords: asset pricing, momentum effect, return correlation, heterogeneous agent model, bounded rationality, computer-based simulations.
JEL:
C6 - Mathematical Methods and Programming: General
 
Manuscript Received : Aug 20 2013 Manuscript Accepted : Dec 30 2013

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