Momentum -Reversal Strategy

Momentum – Reversal Strategy

Hsin-Yi Yu

Assistant Professor, Department of Finance, National University of Kaohsiung 700, Kaohsiung University Rd., Nanzih District 81148, Kaohsiung, Taiwan Tel: +886-7-5919709; Fax: +886-7-5919329; Email: hyyu@nuk.edu.tw

Li-Wen Chen

Assistant Professor, Department of Finance, National Chung Cheng University 168 University Road, Minhsiung Township, Chiayi County 62102, Taiwan Tel: +886-5-2720411 ext. 24213; Fax: +886-5-2720818; Email: lwchen@ccu.edu.tw

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This data and ideas of this paper derive from the authors’ study at Business School, University of Edinburgh. We are sincerely grateful for the valuable comments from Akindynos-Nikolaos Baltas, Jason Wei, Ned Hawley, Russ Abbott, and the seminar participants at the 18th SFM Annual Meeting, the workshop in Kyushu University, National Chung Cheng University, National TsingHua University, and National DongHua University. All errors are the sole property of the author. 1

Electronic copy available at: http://ssrn.com/abstract=1852585

Momentum – Reversal Strategy

Abstract

Various theories have been presented to explain momentum and reversals in stock returns. Based on the model of Hong and Stein (1999), this paper creates a hybrid strategy to avoid the losses from the reversal phase. The risk-adjusted returns of the new strategy are significantly higher than those of the traditional momentum strategy. Moreover, the risk-adjusted returns of the new strategy cannot be fully explained by Carhart’s four-factor model. Such a finding is robust in different time periods and size quintiles. Overall, this paper exploits the interaction between heterogeneous investors and generates distinctive applications.

Keywords: Momentum; Reversal; Overreaction; Underreaction; Timing Ability JEL code: G11, G12, G14

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Electronic copy available at: http://ssrn.com/abstract=1852585

I. Introduction

Can a strategy be created that avoids the process of momentum toward...