Retail investors’ attention and momentum strategies ANNUAL MEETINGS...Retail Investors’ Attention

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Retailinvestorsattentionandmomentumstrategies

EvidencefromtheS&P500

Giorgio Ciocca

University of St. Gallen Bodanstrasse 6

CH-9000 St.Gallen giorgio.ciocca@unisg.ch

Robert Gutsche

University of St. Gallen Bodanstrasse 6

CH-9000 St.Gallen robert.gutsche@unisg.ch

RetailInvestorsAttentionandMomentumStrategies I

Abstract

RelyingonGoogleTrendssearchdatafortheS&P500stocksbetween2004and2015,wefindthat

investinginmomentuminaportfolioofstockswithincreasingsearchactivityminusaportfolio

ofstocksfacingadecreasingsearchactivitydoesnotexhibit,ceterisparibus,significantpositive

momentumreturns.Furthermore,weshowthatretailinvestorsattentioncreatesvolatility.For

that reason, investing in stockswith stable retail investors attention decreases significantly

momentumvolatility.Themomentumeffecthasanegativerelationshipwiththemarkettoneand

does not significantly impact the longterm reversal effect. For those reasons,while general

investors overreact to information as shown byHillert et al. (2014),we conclude that retail

investorsunderreacttoinformation.

RetailInvestorsAttentionandMomentumStrategies 1

1 Introduction

Manypapershavedocumentedthataveragestockreturnsarerelatedtopastperformance.

Trading strategies thatboughtpastwinnersand soldpast losers realize significantabnormal

returns in theUSover the 1965 to 1989period (Jegadeesh andTitman, 1993) and inEurope

between1980and1995(Rouwenhorst,1998).Moreindetail,JegadeeshandTitman(1993)show

that stocks in theUS that realized thebest returnsover thepast3 to12months continue to

performwelloverthesubsequent3to12months.Eveniftheexistenceofthemomentumeffect

hasbeenshownindifferenttimeperiods,countries,indices,andassetclasses,acentralissueis

farfrombeingresolved(Hillert,Jacobs,andSebastian,2014):whataretheunderlyingcausesof

momentum?

Themagnitudeofmomentumprofits is about 12%peryear in theUnited States and

Europe,andsuchanamountisunlikelytobeexplainedbyriskbasedtheoriesorrationalasset

pricingmodels. Indeed,most of the focus in the academic research has been on behavioral

explanationsforthisphenomenon(Chui,Titman,andWei,2010).Somestudiesconcludethatthe

marketunderreacts to information,while others find evidence of overreaction. For example,

Daniel,Hirshleifer,andSubrahmanyam(1998)showhowthemomentumeffectcanbegenerated

by investors overconfidence and selfattribution bias. Their theory implies that investors

overreacttoprivateinformationsignalsandunderreacttopublicinformationsignals.

Mediacoveragedirectlyaffectsthewayinwhichinvestorscollect,process,andinterpret

information(EngelbergandParsons,2011).Hillert,Jacobs,andMller(2014)arguethatinvestors

attentionandinformationprocessingplayacrucialroleinprominentbehavioralfinancetheories

ofmomentum.They find that firms specifically coveredby themedia exhibit, ceteris paribus,

significantly strongermomentum.This effect ishigher if the articleshave apositive tone or

containpositivecontent.However, inthe longrun,theynoticethereversalofthemomentum

return,which ismore pronounced for stockswith high uncertainty and in stateswith high

investorindividualism.Theyconcludebysupportingtheoverreactionbasedexplanationforthe

momentumeffect.

Morerecentpapersstudythenumberofinternetuserslookingforinformationabouta

companyorstockmarket.Theanalysisofinternetsearchqueriescanbeinterpretedasameasure

ofretailinvestorsattentiontothestockmarket.Incontrast,mostprofessionalinvestorsprobably

dont use a search engine to obtain information about the leading stockmarket index (Da,

RetailInvestorsAttentionandMomentumStrategies 2

Engelberg,andGao,2011).Aftersearchingforthestockmarketindex,someindividualsmight

beinclinedtoactandtradeimmediatelyorthefollowingday;theoveralltradingvolumeofthe

stockscomprisingtheDowJonesIndustrialAverage(DowJones)risesafteranincreaseinsearch

queriesfortheindex(DimpflandJank,2015).Ariseininvestorsattentionisfollowedbyhigher

volatility.

Retailinvestorsareoftenconsideredtobeuninformednoisetraders.Empiricalevidence

showsthatretailinvestorslosemoneywiththeirtradingdecisions.Forexample,Grinblattand

Keloharju(2000)analyzeFinlandsuniquedatasettounderstandwhetherdifferencesininvestor

sophisticationsdrivetheperformanceofvariousinvestortypes.Theyfindthatforeigninvestors

outperformdomestichouseholds.

Inthispaper,westudytherelationshipbetweentheretailinvestorsmarketattentionand

thereturnsofmomentumstrategiesontheS&P500intheperiodfrom2004to2015.Theideais

topartiallyreplicatetheanalysisofthemediacoverageeffectsonmomentumreturnsconducted

byHillert, Jacobs, andMller (2014).However, themaindifference is that, instead ofusing

newspaperarticles,wedefinethemediacoverageasgrowthintheresidualGooglesearchesfor

asinglestock.AccordingtoLatoeiro,Ramos,andVeiga(2013),Googleisagoodrepresentative

ofwebsearchqueriesontheInternetduetoitsleadingmarketshare.WhileHillertetal.(2014)

studybothretailandsophisticatedinvestors,withthisstudywecancontributetotheliterature

by focusing on the effect of retail investors attention to themomentum returns. Themain

assumptionofthispaperisthatmostsophisticatedinvestorsarenotlookingfordataonGoogle,

buttheydouseotherinformationproviders,asshownbyDaetal.(2011).

Furthermore,we aim tounderstand if itspossible to explain the futuremediabased

momentum return by analyzing the retail investors confidence in the stockmarkets. One

importantdisadvantageofGooglesearchqueriesisthattheydontallowforresearchonthetone

ofthearticles.Itisnotpossibletounderstandifusersincreasedattentionisduetonegativeor

positive information. For that reason,we use sixGoogle Trend indicators of the investors

confidenceinthestockmarkets,followingPreis,Moat,&Stanley(2013).Ourhypothesisisthe

following:ifinvestorssearchinformationonastockinaperiodinwhichtheconfidenceindicator

queriesarehigh,theywilljudgemoreconfidentlytheinformationtheyget.

Weshowthreemainresults.First,contrarytotheresultsshownbyHillertetal.(2014)

withmedia coverage, investing inmomentum inaportfolioof stockswith increasing search

activityminusaportfolioofstocks facingadecreasingsearchactivitydoesnotexhibit,ceteris

RetailInvestorsAttentionandMomentumStrategies 3

paribus,significantpositivemomentumreturns.However,wenoticepositivebutnotstatistically

significantreturnsbyinvestinginaportfoliooffirmswithstableresidualGooglesearchesand

sellingatthesametimestocksthathadeitherhighincreaseordecreaseinresidualGooglesearch

duringtheprevioussixmonths.

Secondly,weconcludethatamomentumstrategywhichinvestsinaportfolioofstocks

withhighretailinvestorsattentionandsellsaportfolioofstockswithlowinvestorsattention

hasastatisticallysignificantlowervolatilitythanaclassicalmomentumstrategy.However,ithas

ahighervolatility than the strategywhich invests in aportfolio of stockwith stableGoogle

searches.The latterresultshows thatretail investorsattentioncreatesvolatility,asshownby

DimpflandJank(2015).

Thirdly,theanalysisofthetoneofthemarketandofthe longrunreversaleffectdont

show that investors overreact to information. For those reasons,while the general investors

overreacttoinformationasshownbyHillertetal.(2014),weconcludethattheretailinvestors

underreacttoinformation.

Section2ofthispaperdescribesthedatasampleandtheresearchmethod.Insection3,

wepresenttheempiricalresults,and,insection4,weshowtheanalysisofthemarkettoneand

longrunreversaleffect.Section5concludestheresearch.

2 DataandEmpiricalSetup

2.1 Datasample

OurinitialsampleconsistsofallS&P500constituentsasofApril2016,whichareshown

inAppendixA.ThemonthlypricesforthosestocksareretrievedfromThomsonEikonforthe

periodbeginningJanuary2004andendingDecember2015.Weeliminateallconstituentswithout

analyzed prices for the whole period in order to avoid the survivorship bias. After this

adjustment, the sample consists of 435 constituents. We compute monthly continuously

compoundedreturnsforthewholeperiod.

ThedataonsearchqueriesareobtainedthroughGoogleTrends.1WedecidetouseGoogle

Trendsfortwomainreasons.First,accordingtoLatoeiro,,RamosandVeiga(2013),Googleisa

goodrepresentativeofwebsearchqueriesontheInternetduetoitsleadingmarketshare,which

1Source:GoogleTrends(www.google.com/trends)

RetailInvestorsAttentionandMomentumStrategies 4

isabout88%worldwide.2Forthatreason,GoogleTrendsdatarepresentthemajorityoftheUS

population searches. Additionally, Google provides free data, collected on a regular basis

beginningin2004,whichiseasytoaccessandtoanalyze.

Oneof themainchallenges inanalyzingGoogleTrenddata is thechoiceof thesearch

terms.Forexample,bysearchingthetermAPPLE,itisimpossibletounderstandiftheinternet

userwassearching informationaboutAPPLE,Incoraboutfruits.Intheprevious literature,

twomainmethodsareused(Latoeiroetal.,2013).Onepossiblesolutionistolookforthecomplete

nameofthefirm;intheAppleexample,thiswouldbeAPPLEINC.Analternativesolutionis

tousethetickerofthecompany;inthisexample:AAPL.FollowingDaetal.(2011),wedecide

touse the tickerof thecompanyas the search term.By searching the tickerof thecompany,

investorsshowtheirintentiontolookforinformationonthesharepriceofthiscompanyandnot,