Momentum, Information, and Herding

Abstract This study investigates the potential explanations to the momentum effect on the equity market. We primarily discuss the underreaction hypothesis, the overreaction hypothesis, and the impact of herding behavior. We find that the momentum effect disappeared after decimalization in all size deciles, which does not support the underreaction hypothesis. We also find that momentum profits do not exist in any intangible assets or R&D expenses deciles, which is not consistent with the continuous overreaction hypothesis. We further investigate the impact of herding behavior on the momentum effect. Using a new firm-level herding measurement, we find that investors require higher returns in high herding stocks and they require even higher returns in high herding stocks among previous losers, indicating that investors herd against the previous losers while they herd toward the winners.