Rational Momentum Effects

Momentum effects in stock returns need not imply investor irrationality, heterogeneous information, or market frictions. A simple, single-firm model with a standard pricing kernel can produce such effects when expected dividend growth rates vary over time. An enhanced model, under which persistent growth rate shocks occur episodically, can match many of the features documented by the empirical research. The same basic mechanism could potentially account for underreaction anomalies in general.