Academic journal article International Review of Management and Business Research

Interaction of Size and Momentum Effects in Jordan Firms: 2005-2014

Academic journal article International Review of Management and Business Research

Interaction of Size and Momentum Effects in Jordan Firms: 2005-2014

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

Over the past two decades, size and momentum effect has been considered a big challenge to efficient market theory, since in efficient markets the investor cannot achieve profit in the long- term by investing in stocks that have done well recently. In other words, According to efficient markets theory, investors cannot achieve additional returns without bearing additional risk.

One of the great challenges to the CAPM was presented by (Banz, 1981). Banz (1981) described a size effect in stock prices whereby small companies seemed to provide significantly higher monthly returns than did large firms even after adjusting for risk. For the period 1926-1975, the CAPM could not explain the significant differences in the returns between small and large firms. This result suggested that the CAPM is misspecifed (Banz, 1981). Reinganum (1981) confirmed Banz's (1981) results using daily data over the period 1963-1977, as did Brown, Keim, Kleidon and Marsh (1983). Later studies including Fama and French (1992, 1993) and Reinganum (1999) also observed a size effect that could not be explained by the CAPM. Recently, van Dijk (2011) argued that the size effect has not disappeared. He suggested that it is premature to conclude that the size effect has gone away. Chou, Ho and Ko (2012) reported that the size effect is only significant for firms whose size is less than their industry's average size.

Jegadeesh and Titman's (1993) study is considered very important in a momentum literature. They revealed that a strategy of selling past losers and buying past winners generate significant positive return over one year holding period. However, Jegadeesh and Titman (1993) suggest that either serial correlation in industry return components or covariation in firm specific component generate momentum. Although Jegadeesh and Titman's (1993) findings are well accepted, the source of the profits and the explanation of the evidence are considerably debated.

Fama and French (1996) find that intermediate-horizon price momentum cannot be explained by threefactor model of returns. Chan, Jegadeesh and Lakonishok (1996) aim to trace the sources of the predictability of expected returns depending on past returns. They show that under-reaction to earnings news can partially explain intermediate-horizon return continuation, but that price momentum is not subsumed by earnings momentum. Rouwenhorst (1998) show a comparable pattern of intermediate-horizon price momentum in twelve other countries, proposing that the impact is not likely based on a data snooping bias. Conrad and Kaul (1998) suggest hypothesis that are based on idea that momentum strategies earn positive returns on average either the expected return on stocks or both irregular or constant over time. Conrad and Kaul (1998) propose that the momentum effect is generated by cross-sectional differences in the unconditional mean returns of individual securities. In particular, they demonstrate that most of the trading profits arise from the serial correlation in industry return and this finding is consistent with Jegadeesh and Titman (1993).

Daniel, Hirshleifer and Subrahmanyam (1998) present behavioural explanation of return persistence and reversals suggesting that investors display overconfidence and self-attribution biases, especially in certain kinds of industries over time. Overconfidence among investors may be generated by the difficulty in estimating the value of new or changing industries. These investors are simultaneously employed in these sectors or avocation associated with these sectors, which overstates industry mispricing. Hong and Stein (1999) present another behavioural explanation of return persistence and reversals pointing out that an initial under-reaction to news can be generated by disseminating slow information into prices, but the existence of momentum traders searching to utilize the slow price movement generates following reversals. …

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