On the source of contrarian and momentum strategies in the Italian equity market

This paper investigates the source of momentum profits, while inferring the validity of the assumptions underlying rational and behavioural theories. Using a unique sample of securities listed in the Italian Stock Exchange from 1950 to 1995, we observe that buying better performing stocks in the previous 3-12 months and selling worse performing stocks over the same period yields significant profits in the short term (less than 1 year). Results also hold when conditioned upon different risk specifications. On the other hand, the continuation effect seems to significantly revert over a longer period. More importantly, in contrast with Conrad and Kaul [Rev. Financ. Stud. 11 (1998) 489], bootstrap and Monte Carlo simulations show that momentum profits are more likely to be generated by stock returns time series properties rather than by their cross-sectional differences. While the overall findings cannot reject the market efficiency hypothesis, we argue that behavioural theory may be a possible “story” to interpret the continuation effect.