Market Efficiency - Momentum
Introduction
The concept of market efficiency has been a hotly debated issue in finance due to its wide ranging implications on the finance industry. The efficient market hypothesis states that market prices fully reflect the information that is publically available hence implies that there are no possibilities to attain abnormal profits (Fama 1970). Under the assumptions of an efficient market, new information should quickly and accurately be incorporated into the market price leaving no room for traders to abnormally profit. Intuitively, the assumption that traders cannot beat the market undermines many of the roles in the modern finance industry such as active portfolio management and technical analysis.
There are a plethora of research articles that try to empirically test the level of market efficiency and prove that stock prices do not follow a random walk (Lo and Mackinlay 1988). Some of these articles focus on anomalies that should not hold true in an efficient market and other articles try to dispel those anomalies. Market efficiency anomalies such as momentum, reversal effects, book-to-market effects and post-earnings-announcement drifts have contributed to the argument against the idea of market efficiency.
Momentum
Jegadeesh and Titman 1993 aimed to investigate the returns on stocks that had previously performed well (winners) and sell stocks that had previously performed badly (losers). The study showed that significant abnormal returns could be generated within the first 12 months by investing in a portfolio consisting of the top 10 per cent of winners and losers. The research and its findings relating to price momentum have been cited in many other works and forms the backbone of many discussions based on market efficiency. The results were obtained over a period from 1965 to 1989 and clearly defy the weak form of market efficiency which states that prices should already reflect historical prices (Fama 1970). The fact that Jegadeesh
The concept of market efficiency has been a hotly debated issue in finance due to its wide ranging implications on the finance industry. The efficient market hypothesis states that market prices fully reflect the information that is publically available hence implies that there are no possibilities to attain abnormal profits (Fama 1970). Under the assumptions of an efficient market, new information should quickly and accurately be incorporated into the market price leaving no room for traders to abnormally profit. Intuitively, the assumption that traders cannot beat the market undermines many of the roles in the modern finance industry such as active portfolio management and technical analysis.
There are a plethora of research articles that try to empirically test the level of market efficiency and prove that stock prices do not follow a random walk (Lo and Mackinlay 1988). Some of these articles focus on anomalies that should not hold true in an efficient market and other articles try to dispel those anomalies. Market efficiency anomalies such as momentum, reversal effects, book-to-market effects and post-earnings-announcement drifts have contributed to the argument against the idea of market efficiency.
Momentum
Jegadeesh and Titman 1993 aimed to investigate the returns on stocks that had previously performed well (winners) and sell stocks that had previously performed badly (losers). The study showed that significant abnormal returns could be generated within the first 12 months by investing in a portfolio consisting of the top 10 per cent of winners and losers. The research and its findings relating to price momentum have been cited in many other works and forms the backbone of many discussions based on market efficiency. The results were obtained over a period from 1965 to 1989 and clearly defy the weak form of market efficiency which states that prices should already reflect historical prices (Fama 1970). The fact that Jegadeesh
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