When Narasimhan Jegadeesh, Dean’s Distinguished Chair in Finance at Emory University’s Goizueta Business School, co-authored a paper in 1993 with Sheridan Titman, the scholars thought their work — “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency” — would contribute to the body of knowledge surrounding the profitability of a “momentum-based” stock-trading strategy, which involves buying shares of companies that have seen price gains in the past while selling shares that previously declined in price.
In fact however, the paper spurred a two-decade effort by scholars across the globe to take a deeper look at the conclusions reached by Jegadeesh and Titman, even as later studies continued to validate their original observations.
On March 15 Jegadeesh and his co-author’s classic paper was honored as work that has inspired many advances in the field and withstood the test of time in the conference “Finance Down Under: Building on the Best from the Cellars of Finance,” organized by The Department of Finance in the Faculty of Business and Economics at the University of Melbourne, Australia.
Before the event, which featured top researchers presenting their latest studies on the topic, Goizueta Newsroom caught up with Jegadeesh and asked him about his world-shaking publications.
Goizueta Newsroom: Could you sum up the observations in your original paper?
Jegadeesh: The central finding of our paper was that stocks that performed well in the past continued to perform well for up to 12 months in the future, and stocks that performed poorly continued to do so in the future. Interestingly, a large part the price momentum gains reversed themselves in the following two years. Our results provided new insights into how investors process information and how some of investors’ behavioral biases are reflected in pattern of price changes.
Goizueta Newsroom: Why was that significant?
Jegadeesh: Our paper was written at a time when the accepted wisdom among academics was that price changes are unpredictable and that markets are fully efficient. The primary empirical evidence at that time that challenged this notion was evidence of long term price overreaction, which resulted in stocks that performed well over the past three to five years underperforming in the future. Such evidence suggested that investor tend to overreact to information, but this evidence was generally considered weak. Our evidence was much stronger and we found that an important investor bias that underlies our finding is underreaction rather than overreaction. Since our findings challenged the prevailing wisdom, it had a major impact.
Goizueta Newsroom: Would it be accurate to say that your initial conclusions appear to have been validated by later studies?
Jegadeesh: That is correct. I published a paper with Louis Chan and Josef Lakonishokin 1996 and another paper with Sheridan Titman in 2001 that extended our original findings. The 2001 paper was also significant because we found the same trends a decade after the first paper, which helped to validate our results out-of-sample.
Over the last twenty years numerous papers that examined a variety of issues related to momentum were published by other researchers as well. Some of them examined the characteristics of stocks that are exhibited bigger price momentum than others and some focused on identifying periods when momentum strategies are likely to be most profitable. The literature also found that momentum is an international phenomenon that is observed in the European markets as well.
A related line of research developed theories that relied on behavioral biases that explained momentum and longer term return reversals. The momentum paper therefore contributed to the development of the field of behavioral finance as well.
Goizueta Newsroom: What are the practical and scholarly values of your findings?
Jegadeesh: Portfolio managers who use quantitative trading strategies typically incorporate trading signals based on price momentum into their models. From an academic perspective, it is more important to understand how the market processes information. The evidence we presented added to the literature documenting that the market tends to underreact to information. In others papers, I also found that the market underreacts to revenue momentum, and that analysts are slow to react to information in price changes. These findings contributed to the evolution of our understanding of the shortcomings of the efficient markets hypothesis, which is a central hypothesis in finance.
Goizueta Newsroom: Congratulations. Did you think your work would be honored 20 years down the road?
Jegadeesh: We were pretty confident about our results back in 1993, but I did not think that 20 years later this work would be honored in an international conference. However, within four years or so of our publication it became clear that the conclusions were generating a lot of interest. Even today, many researchers continue to build on the work. Personally, I am now looking into the role that other factors play in momentum strategies. It’s an area that is still wide open for study.