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DP6588 Advance Information and Asset Prices

Author(s): Rui Albuquerque , Jianjun Miao
Publication Date: November 2007
Keyword(s): advance information , momentum and reversal effects , overreaction , rational expectations equilibrium , underreaction
JEL(s): G11 , G12 , G14
Programme Areas: Financial Economics
Link to this Page: www.cepr.org/pubs/dps/DP6588.asp.asp


This paper provides an explanation for momentum and reversal in stock returns within a rational expectations framework in which investors are heterogeneous in their information and investment opportunities. We assume that informed agents privately receive advance information about company earnings that materializes into the future. While this information is immediately incorporated into prices, stock prices underreact to it causing short-run momentum. Stock prices may appear to move in ways unrelated to current fundamentals. When the information materializes, the stock price reverts back to its long run mean mimicking an overreaction pattern.

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