BEHAVIORAL BIASES AND THE MOMENTUM EFFECT EMPIRICAL TEST OF THE PERFORMANCE OF WINNER AND LOSER PORTFOLIOS IN THE HELSINKI STOCK EXCHANGE FROM 2001 TO 2006

Abstract

Behavioral Finance argues that investor behavior influences stock prices, and it causes the security price deviate from its fundamental value. These irrational investors which influence asset prices by acting according to their feelings are called noise traders. Noise trading is about taking a position in a stock with false information and keeping that position even though there might some information in the markets about the stock which is more important and would state otherwise.

Behavioral finance is an argument against the efficient market hypothesis which states that the asset prices include all information there is in the markets. Behavioral finance relaxes the most important assumption of traditional finance theory, investor rationality. If psychological concepts such as heuristic simplification, mental accounting, reference effects, self-deception and self-control affect human behavior, should they not also affect investor behavior and the stock prices?

In this study the overreaction of the stock markets will be followed by forming two portfolios: the past losing stocks and the past winning stocks. The performance of these portfolios will be followed and analyzed in a four year period. It was discovered that the past losing portfolios outperform the winning portfolios in a short period of time (3-24 months after). However, 48 months after the portfolio formation, the winning portfolios were making far better returns.