Momentum, reversal, and the trading behaviors of institutions

We identify two types of momenta in stock returns-one due to returns relative to other stocks and one due to firm-specific abnormal returns, where abnormal is determined by a stock's idiosyncratic return variation. Despite similar performances over the first year, these momentum portfolios perform dramatically differently beyond year one. Relative-return momentum reverses strongly; abnormal-return momentum continues for years. This complexity in return momentum challenges the current theories of momentum. We propose that both momenta are consequences of agency issues in the money management industry and provide empirical support for this economic rationale of momentum in returns. Incentives induce institutions to chase relative returns and to underreact to firm-specific abnormal returns.