Price reversal and heterogeneous belief

Abstract

We consider that due to the average belief of investors on a stock changing from bullish (bearish) to bearish (bullish) during an entire reversal process, it is a special characteristic that investors’ beliefs are more heterogeneous during the belief-adjusted period. Therefore, high heterogeneous belief is helpful to capture accurately stock price reversals and lead to stronger short-term reversal effects. We examine the role of the investor heterogeneous belief (HB) on the standard reversal (RVS). Our empirical evidence in the Chinese stock market shows that higher HB results in lower (higher) future returns for past winners (losers); in particular, extremely low HB indicates the absence of subsequent reversal for past winners. Furthermore, we define a new reversal measure of NewRVS and show that NewRVS outperforms RVS. Our regression results confirm that: (1) NewRVS has a stronger impact on future returns than RVS; (2) low HB is related to the absence of reversal or a weak reversal; (2) high HB amplifies the reversal effect.