A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets

A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets

  • Harrison Hong
  • Jeremy C. Stein

Article first published online: 17th December 2002 DOI: 10.1111/0022-1082.00184

Abstract


We model a market populated by two groups of boundedly rational agents: “newswatchers” and “momentum traders.” Each newswatcher observes some private information, but fails to extract other newswatchers' information from prices. If information diffuses gradually across the population, prices underreact in the short run. The underreaction means that the momentum traders can profit by trend‐chasing. However, if they can only implement simple (i.e., univariate) strategies, their attempts at arbitrage must inevitably lead to overreaction at long horizons. In addition to providing a unified account of under‐ and overreactions, the model generates several other distinctive implications.

Sign in to access the full article.

Related articles


Front Matter

Article first published online: 29th January 2016 / DOI: 10.1111/j.1540-6261.1999.tb00623.x

Read Article

Back Matter

Article first published online: 29th January 2016 / DOI: 10.1111/j.1540-6261.1999.tb00624.x

Read Article

Book Reviews

Article first published online: 31st March 2007 / DOI: 10.1111/1540-6261.00193

Read Article

Herding and Feedback Trading by Institutional and Individual Investors

  • John R. Nofsinger
  • Richard W. Sias

Article first published online: 17th December 2002 / DOI: 10.1111/0022-1082.00188

Read Article

The Impact of Trader Type on the Futures Volatility‐Volume Relation

  • Robert T. Daigler
  • Marilyn K. Wiley

Article first published online: 17th December 2002 / DOI: 10.1111/0022-1082.00189

Read Article

The Corporate Cost of Capital and the Return on Corporate Investment

  • Eugene F. Fama
  • Kenneth R. French

Article first published online: 17th December 2002 / DOI: 10.1111/0022-1082.00178

Read Article

Are you an Author?


Please read our submission requirements and find out how to submit your paper to the Journal of Finance

Submit a paper