John Crombez

Momentum, Rational Agents and Efficient Markets

Descriptive behavioral models explain the momentum anomaly by assuming that financial agents are irrational. However, investors are not tested to be susceptible to the cognitive failures observed in psychological experiments. We consider an environment where financial agents are rational, markets are efficient as defined by the Grossman-Stiglitz [1980] efficiency, and there are market imperfections in the information market. Based on a simulation experiment, we find that returns on momentum strategies can exist in this environment because of the noise in expert information. We empirically find that even in a sample of large and liquid stocks, this noise is still observable and, hence, momentum can be empirically found for these samples even when agents are rational and markets are efficient.