Saturday, June 04, 2005


Academic Paper: Heterogeneous Beliefs and Momentum Profits

This paper tests the effect of disagreement on momentum. Previous empirical studies link measures of a stock's visibility and investor recognition to the speed of information diffusion, and establish that momentum is larger for small, less followed stocks. I test the hypothesis that heterogeneity of beliefs implies slower incorporation of information into prices and translates into return continuation. Using the dispersion of analyst forecasts of earnings and trading volume as measures of heterogeneity of beliefs, I find that momentum profits are significantly larger for portfolios characterized by higher heterogeneity. The effect of disagreement on return continuation is distinct from the effect of visibility and investor recognition measured by size, analyst coverage, and the quantity of news headlines about a stock. These results still hold for individual stock returns in a multiple regression setting, and are not driven by short-sale constraints.

Collectively, the findings in this paper suggest that heterogeneity of beliefs provides information on the profitability of momentum strategies that is not subsumed by conventional proxies for the speed of information diffusion. When studying the nature of return continuation, the quantity of information available about an asset should be considered together with investors' disagreement about it.

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