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The IUP Journal of Behavioral Finance :
Momentum and Reversal Puzzle in Emerging Markets
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Empirical research about the existence of momentum and reversal phenomena in emerging stock markets shows that momentum profits are in general positive but not always economically and statistically significant. This paper re-examines the momentum and reversal phenomena in 15 emerging markets, using data from 1995 to 2005. The results are quite different from previous literature where significant evidence has been found of reversals in most of the emerging stock markets, even when they were controlled for systematic risk and size. There are many possible explanations for this puzzle. One common interpretation for the momentum phenomenon in the short-term is the slow diffusion of information, leading to an underreaction in the markets.

Among the growing literature in behavior finance, two phenomena have attracted attention and they are, momentum and reversal. While the momentum phenomenon is the continuation of past returns, i.e., past winners continue to beat past losers, the reversal phenomenon is exactly the inverse, i.e., past losers outperform past winners. DeBondt and Thaler (1985) wrote one of the first articles to assess strategies based on past returns. They documented a reversal phenomenon with data from the US where long-term past losers outperform long-term past winners over a subsequent period of three to five years. On the other hand, Jegadeesh and Titman (1993) proved that in the short-term there is a momentum in the US data since for three to 12 months, past winners have continued to outperform past losers.

There are two types of explanations for these phenomena: behavior based and risk based. Among the behavior-based explanations for such phenomena, underreaction and overreaction are the most common (see Chopra et al., 1992; Barberis et al., 1998; and Hong and Stein, 1999). The underreaction of stock prices due to news (for example, earnings announcements) may cause the momentum, since a slow diffusion of information among investors could make the path to the `correct' value of the stock longer than expected. But, for longer periods, an overreaction of stock prices may occur due to extrapolation of a series of good or bad news, especially if investors are overconfident.

 
 
 

Leader Brands, Empirical research, emerging stock markets, behavior finance, momentum phenomenon, stock prices, Empirical evidence, domestic investors, systematic risk, Emerging markets, individual investors, systemic-risk-free portfolio.