Momentum and Reversal Simply Reactions to Noise?
Posted in Momentum Investing
December 21, 2012
What causes asset price momentum? In his May 2012 paper entitled “Is Momentum a Self-fulfilling Prophecy?”, Steven Jordan presents a simple, abstract model explaining the pervasiveness and robustness of evidence for intermediate-term momentum and long-term reversal. The essential assumptions of his model are: (1) demand for an asset is noisy and flat or downward sloping with price; (2) supply of an asset is noisy and flat or upward sloping with price; and, (3) some traders believe that lagged price trends tend to persist and act on this belief, with their actions scaled by the magnitude of lagged noise. He assumes that demand and supply slopes are linear to simplify formulas. Deriving time series behaviors from this model, he concludes that: (more…)