Can Momentum Be Explained by Fund Flows or Disposition Effect? The Impact of Behavioral Biases and Capital Flows in Brazilian Market Movements

Abstract

Momentum is one of the most robust anomalies in financial markets, there are two main recent explanations for this phenomenon, a behavioral-based explanation through disposition-effect (i.e., the willingness to sell “winners” too quickly and to hold “losers” for a long time) and a fund-flow based explanation. The disposition-effect explanation is centered in the convergence of the spread between the fundamental value and the observed market price (dispositioneffect causes an underreaction to news that generates this spread), and the fund flows-based explanation is due to the persistence of the performance of mutual-funds (which usually keep buying winning positions and selling the losses). This paper compares those theories using Brazilian data (which is suitable for the strong presence of momentum). The empirical analysis was done using Fama-MacBeth regressions with results pointing the disposition-effect explanation as the most significant, with the robustness analysis contributing positively to the main findings.