Analysis of the causes of the momentum effect and their implications for the efficient market hypothesis

Abstract

The Efficient Market Hypothesis has largely been discussed in financial literature. Some authors are in favor and others disagree, but one anomaly is particularly in contradiction with the market efficiency: the momentum effect. The main goal of this thesis is to contribute to the momentum puzzle in trying to explain the causes of asset price continuation on medium term. Double sorted portfolios on past prices and investor attention of stocks from the composition of S&P 500 are formed to demonstrate the superior performance of strategy based both on price and investor attention. The results confirm the influence of investor biases on the formation of momentum. An “investor attention effect” is discovered in the S&P 500 and proven to be only present in momentum stocks. However, differences in investor attention do not seem to completely explain the momentum effect, and should probably cause momentum with another factor such as a risk-based one. This study contradicts the Efficient Market Hypothesis, but emphasizes that this conclusion should be taken cautiously into account and further analyzed.