Abstract
There are two commonly recognized anomalies in the stock market, namely short-run momentum and long-run reversals. Under these two financial market anomalies, there are two trading strategies – momentum trading and contrarian trading – that can be adopted for the purpose of making profits. We model an asset market in which momentum traders, contrarian traders and informed rational speculators make transactions. We discovered that under certain conditions, the self-profiting motive of informed speculators will lead to their price manipulation behaviors, and result in momentum and reversals phenomenon on the asset price. We also found that the scenario of the relative quantity of the two types of behavioral traders and their profit margins is similar to that of a minority game.
Highlights
1.1 Introduce the ProblemEmpirical studies on the equity markets have documented two well-known stylized facts about stock returns
Is it the existence of macro phenomena that lead to the traders‟ micro behaviors for profiting? Or, does the macro phenomena of special anomalies exist because the micro-behaviors aggregate and interact with each other? This has always been an issue researchers would like to figure out
Most of the past literature consider the gradual flow of information as the cause to the underreaction of stock price and momentum
Summary
Empirical studies on the equity markets have documented two well-known stylized facts about stock returns. E.g., Rouwenhorst (1998), Galariotis et al (2007) and Doan et al (2014), among others Such macro empirical phenomena will provide profit margin for the two classes of traders using return-based trading strategies, namely, momentum trading and contrarian trading under respective investment time horizons.. Slezak (2003) provided a model of an asset market where rational and irrational traders make transactions Their irrational traders‟ trading strategies can create momentum and reversals in the equilibrium asset price. They showed that the phenomena of momentum and reversals will persist even in the presence of fully rational traders in the asset market.
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