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Short-Term Momentum and LongTerm Reversal of Returns under Limited Enforceability and Belief Heterogeneity

Author

Listed:
  • Beker, Pablo F.
  • Espino, Emilio
Abstract
We evaluate the ability of the Lucas [25] tree and the Alvarez-Jermann [3] models, both with homogeneous as well as heterogeneous beliefs, to generate a time series of excess returns that displays both short-term momentum and long-term reversal, i.e., positive autocorrelation in the short-run and negative autocorrelation in the long-run. Our analysis is based on a methodological contribution that consists in (i) a recursive characterisation of the set of constrained Pareto optimal allocations in economies with limited enforceability and belief heterogeneity and (ii) an alternative decentralisation of these allocations as competitive equilibria with endogenous borrowing constraints. We calibrate the model to U.S. data as in Alvarez and Jermann [4]. We find that only the Alvarez-Jermann model with heterogeneous beliefs delivers autocorrelations that not only have the correct sign but are also of magnitude similar to the US data.

Suggested Citation

  • Beker, Pablo F. & Espino, Emilio, 2015. "Short-Term Momentum and LongTerm Reversal of Returns under Limited Enforceability and Belief Heterogeneity," Economic Research Papers 269729, University of Warwick - Department of Economics.
    • Handle: RePEc:ags:uwarer:269729
    DOI: 10.22004/ag.econ.269729
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    Cited by:

    1. Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2019. "Momentum and reversal in financial markets with persistent heterogeneity," Annals of Finance, Springer, vol. 15(4), pages 455-487, December.

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