Momentum Returns and Information Uncertainty

Prior literature attributes returns of the momentum trading strategy to investor behavioural biases, such as under reaction to new information, and provides evidence that firms with higher information uncertainty earn lower future returns and higher momentum returns. This study investigates the relationship between information uncertainty, future returns and the momentum trading strategy in China, over 1994 to 2010. Using age, volatility, volume and firm size as information uncertainty proxies, we find that firms with higher information uncertainty earn higher average returns over the succeeding 6-month period when information uncertainty is defined in terms of firm size, volume and volatility, consistent with the traditional asset pricing models. However, firms with high information uncertainty earn lower returns if information uncertainty is defined in terms of firm age; however, firm age might not be an important factor in explaining future returns as the age difference among young and old firms is quite small and it might be the other firm-specific characteristics that drive lower future returns for the younger firms instead of their age. Therefore, our study rejects the findings of Jiang, Lee and Zhang (2005) that stocks with higher information uncertainty earn lower returns over the succeeding 6-month period. Using portfolio level analysis and firm-level Fama and Macbeth regressions, we find that no robust significant relationship exists between information uncertainty and momentum returns. Our findings suggest that it might be the activities of retail investors that drive momentum returns since China’s market is dominated by retail investors, whereas the momentum effect is weak among the U.S. stocks with higher institutional holdings.