The Momentum Effect: An Empirical Study of the Momentum Effect in Sectors and the Influence of Investor Attention

Ida Maria Dahl Høm & Sandra Damsbo Mårtensson

Student thesis: Master thesis

Abstract

The purpose of this thesis is to investigate the momentum effect on a sector level and address the issue whether attention can be an explanatory variable. The relationship between momentum and attention is analyzed for the total period 2004-2018, while also a deep diving into different market states. The different market states are an up-market period and a down-market period, which provides a more comprehensive understanding of the market. The thesis is based on a theoretical framework within behavioral finance, considering the irrationality in human behavior when reacting to information as well as in decision making. From this, Jegadeesh and Titman (1993) investigated the momentum effect and their methodology will be the essence in the creation of momentum portfolios. We composed portfolios for the US stock market for 11 different sectors based on the SP500. Furthermore, three attention measures were chosen to conduct the analysis of the relationship between momentum and attention; trading volume, analyst recommendation and market cap, where trading volume has the main focus since it is a more direct measure. Attention as an explanatory variable were examined by a linear relationship along with a regression showing the effect of a change in attention on momentum return as the dependent variable. The results showed positive momentum returns for all the sectors for the total period and upmarket. For the down-market, positive momentum returns were found, though with lower returns and a few negative for some sectors. A positive linear relationship between attention and momentum were found; higher attention generates a positive effect on momentum return. This was present for the total period and up-market indicating that attention can be an explanatory variable for momentum. In the down-market this linear relationship faded and instead of higher attention having a positive effect on momentum, almost all sectors except for one exhibited negative effect on momentum return if attention increased, why attention no longer is an explanatory variable for the momentum effect when looking at a down-market state. The evidence could be related to over- and underreaction driven momentum, where especially overreaction driven momentum could be the explanation for the up-market and underreaction driven momentum for the down-market.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2019
Number of pages135
SupervisorsJimmy Martínez-Correa