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Daily momentum and contrarian behavior of index fund investors

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The authors use a two-year panel of individual accounts in an SandP 500 index mutual fund to examine the trading and investment behavior of more than 91000 investors who have chosen a low-cost, passively managed vehicle for savings. This allows them to characterize investors' heterogeneity in terms of their investment patterns. In particular, they identify positive feedback traders as well as contrarians whose activities are conditional upon preceding day stock market moves. They test the consistency and profitability of these conditional strategies over time. The authors find that more frequent traders are typically momentum investors, while infrequent traders are more typically contrarians. The dynamics of these investor classes help them to partially examine the question of the marginal investor over the period of the study. They find that the behavior of momentum investors is typically correlated to changes in the SandP 500 and they trace its dynamics over time. They build up "behavioral factors" based on contrarian and momentum flows and show that they perform well against a benchmark of loadings on latent factors extracted from returns. The authors also use the behavior of momentum and contrarian investors to build a measure of "market polarization". This captures the dispersion of beliefs among the investors and helps to account for asset pricing better than standard measures of dispersion of beliefs.

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