Implications from Biased Probability Judgments for International Disparities in Momentum Returns

ABSTRACT

Momentum is a consistent phenomenon in financial data from the majority of markets around the globe. One prominent exception is the Japanese market, where returns from a momentum-investment strategy are nonexistent. The authors investigated international differences in the representativeness heuristic, which is one potential driver of momentum. After observing sequences of a random walk, subjects give probability estimates for the direction of the respective next change. The experiment was conducted in Japan and in Germany. For a subgroup of participants with lower cognitive abilities our results are perfectly in line with international momentum evidence.

KEYWORDS:

• Momentum
• Culture
• Japan
• Law of small numbers
• Cognitive reflection test

Acknowledgments

The authors want to thank Jeannette Brosig-Koch and Werner Pascha for their advice and valuable feedback.

Funding

The Deutsche Forschungsgemeinschaft (German Science Foundation, DFG) funded this project within the Research Training Group 1613.