Individualism, Uncertainty Avoidance and the Profitability of Momentum Strategies in International Markets

Abstract

Prior research shows that momentum returns are unlikely to be explained by risk-based theories. Daniel, Hirshleifer, and Subrahmanyam (1998) show that momentum effect can be explained by investors overconfidence and self-attribution bias while Barberis, Shleifer, and Vishny (1998) and Hong and Stein (1999) document that momentum effect can be explained by investors under-reaction to information. Chui et al. (2010) document that cultural differences influence the returns of momentum strategies. Motivated by these studies, we examine the relationship between cognitive biases and the profitability of price and earnings momentum strategies in international markets. Specifically, we address two questions. First, we investigate the relationship between individualism, uncertainty avoidance and price momentum returns. Second, we investigate the relationship between individualism, uncertainty avoidance and earnings momentum returns. Using data from 41 countries we show that (1) the level of individualism in different countries is positively associated with the profitability of price and earnings momentum strategies, (2) the degree of uncertainty avoidance is negatively associated with the earnings momentum profits, but not correlated with price momentum profits. Collectively, our findings suggest that the variation in the profitability of price and earnings momentum strategies can be attributed to cognitive biases.

Keywords: Post-earnings announcement drift, Individualism, Price momentum, Earnings Momentum, Uncertainty avoidance, Culture

JEL Classification: G12, G14, G15