Download or read book Sentiment and Momentum written by John A. Doukas and published by . This book was released on 2019 with total page 54 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper sheds empirical light on whether sentiment affects the profitability of price momentum strategies. We hypothesize that news that contradicts investors' sentiment causes cognitive dissonance, which slows the diffusion of signals that oppose the direction of sentiment. This phenomenon tends to cause underpricing of losers under optimism and underpricing of winners under pessimism. While the latter phenomenon can be corrected by arbitrage buying, short-selling constraints impede arbitraging of losers under optimism, causing momentum to be stronger in optimistic periods. Our empirical analysis supports this argument by showing that momentum profits arise only under optimism, and are driven principally by strong momentum in losing stocks. This result survives a host of robustness checks including controls for market returns, firm size and analyst following. An analysis of net order flows from small and large trades indicates that small (but not large) investors are slow to sell losers during optimistic periods. Momentum-based hedge portfolios formed during optimistic periods experience long-run reversals.