Betting Against Winners

We propose a dynamic model in which speculators disagree about firm value, but are faced with short-sale constraints, which results in dynamic mispricing effects. We test this model using a combination of institutional ownership, recent changes in short interest, and recent past returns (“momentum”) as a proxy for overpricing. Consistent with this model, we find that a subset of high momentum firms earns persistently low returns going forward. A “Betting Against Winners” strategy that goes short the overpriced winners and long other winners generates a Sharpe-ratioof 1.08; its returns cannot be explained by commonly used risk-factors.