What Leads To Short-term Momentum Effect And Long-term Reversal Effect

This paper propose a new theoretical mechanism to explain the short-term momentum effect and long-term reversal effect based on salience decision theory.By including both rational investors and salience-thinking investors into a multi-periods asset pricing model,this paper illustrates that,behavioral bias of salience-thinking investors will lead to short-term momentum effect.Meanwhile,arbitrage behavior of rational investors when news releasing will push the stock price into a reasonable price range,leading to the long-term reversal effect.Further analysis shows that,the strength of momentum effect and reversal effect will increase with the growth of the extent of salience-thinking investors' irrationality,salience of stocks and proportions of shares held by institutional investors.To test the robustness of the theoretical analysis,this paper then check the theory by agent-based simulation analysis model.Through a 30-term simulated stock market,rational investors and salience investors' trading behavior determine the stock price together.The simulation results show that,when the salience investors exist in the stock market,the short-term momentum effect will arise.The new published news will cause the long-term reversal effect,which prove the theoretical analysis of this paper again.This paper test my theoretical model through stock data in China's A share market from 1990 to 2018.The results show that,both effect will increase with the growth of salience of stocks and the increase of the proportion of shares held by institutional investors will suppress both effects.The results above are still significant after adding other pricing factors as control variables.The empirical results supports the theory in this paper,thus providing new theoretical explanation and empirical evidence for the short-term momentum effect and long-term reversal effect.