Cognitive Dissonance, Sentiment, and Momentum

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 constrai...

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Bibliographic Details
Published inJournal of financial and quantitative analysis Vol. 48; no. 1; pp. 245 - 275
Main Authors Antoniou, Constantinos, Doukas, John A., Subrahmanyam, Avanidhar
Format Journal Article
LanguageEnglish
Published New York, USA Cambridge University Press 01.02.2013
Subjects
Arbitrage
Arithmetic mean
Cognitive dissonance
Consumer confidence
Financial portfolios
Investor behavior
Investors
Macroeconomics
News
Optimism
Pessimism
Portfolios
Price momentum
Profitability
Profits
Quantitative analysis
Short sales
Stock prices
Time series
Winners
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Summary: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.
ISSN:0022-1090
1756-6916
DOI:10.1017/S0022109012000592