Do culture, sentiment, and cognitive dissonance explain the ‘above suspicion’ anomalies?

DOIhttp://doi.org/10.1111/eufm.12203
Published date01 November 2019
Date01 November 2019
DOI: 10.1111/eufm.12203
ORIGINAL ARTICLE
Do culture, sentiment, and cognitive dissonance
explain the ‘above suspicion’ anomalies?
Ali Altanlar
1
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Jiaqi Guo
2
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Phil Holmes
1
1
Leeds University Business School,
University of Leeds, Leeds LS2 9JT, UK
Emails: A.Altanlar@lubs.leeds.ac.uk;
prh@lubs.leeds.ac.uk
2
School of Economics, Finance and
Accounting, Faculty of Business and
Law, Coventry University, Coventry CV1
5ED, UK
Email: ac9510@coventry.ac.uk
Abstract
We investigate how cognitive dissonance arising from
interactions between sentiment and culture affects momen-
tum and post-earnings-announcement-drift (PEAD). We
focus on differing views relating to change between western
and East Asian cultures. Building on Hong and Stein's
heterogeneous trader model and recognizing westerners’
(easterners’) belief in continuation (reversal), we propose
cognitive dissonance arises in different circumstances and
to differing degrees in the two cultures, resulting in it being a
key driver of the anomalies. Results support our hypotheses,
suggesting sentiment and culture interact to impact
cognitive dissonance, explaining differences in the anoma-
lies across countries evident in prior literature.
KEYWORDS
cognitive dissonance, culture, investor sentiment, momentum, post-
earnings-announcement-drift
JEL CLASSIFICATION
G14, G41, G4
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INTRODUCTION
In his review of long-term returns and behavioral finance, Fama (1998) poses and answers a question:
We are very grateful to the editor, John Doukas, and an anonymous referee for insightful comments on earlier drafts which
have helped to improve the quality of the paper.
Eur Financ Manag. 2018;1–28. wileyonlinelibrary.com/journal/eufm © 2018 John Wiley & Sons, Ltd.
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1168 © 2018 John Wiley & Sons, Ltd. wileyonlinelibrary.com/journal/eufm Eur Financ Manag. 2019;25:1168–1195.
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Which anomalies are above suspicion? The post-earnings-announcement drift ... has
survived robustness checks, including extension to more recent data.... The short-term
continuation of returns documented by Jegadeesh and Titman (1993) is also an open
puzzle, but it is still rather new and further tests are in order. (p. 304)
Since Fama's paper, considerable research has continued to support the robustness of the
findings in relation to post-earnings-announcement-drift (PEAD), and the further tests of
momentum which Fama called for have generally confirmed the earlier findings, meaning that
this anomaly remains ‘an open puzzle.
1,2
Numerous arguments have been put forward to try to
explain these anomalies, both from a theoretical perspective and in terms of empirical analysis. For
example, behavioral-based theoretical models have been developed by Daniel, Hirshleifer, and
Subrahmanyam (1998), Barberis, Shleifer, and Vishny (1998), and Hong and Stein (1999) based on
either psychological biases (e.g., overconfidence, representativeness, self-attribution bias) or
bounded rationality within a heterogeneous trader model. In terms of empirical evidence, examples
include the role of market state (Cooper, Gutierrez, & Hameed, 2004), macroeconomic risk or
conditions (Chordia & Shivakumar, 2002; Liu & Zhang, 2008), international rather than national
risk (Asness, Moskowitz, & Pedersen, 2013; Fama & French, 2012), culture (Chui, Titman, & Wei,
2010; Dou et al., 2015), sentiment (Antoniou et al., 2013), the role of aspects of information
(diffusion, asymmetry) and conservatism (Chen, Chou, & Hsieh, 2017; Da, Gurun, & Warachka,
2014; Doukas & McKnight, 2005), arbitrage risk (Mendenhall, 2004), security analyst experience
(Mikhail, Walther, & Willis, 2003), transaction costs (Agyei-Ampomah, 2007), dispersion in
analysts’ forecasts and analyst forecast errors (Dische, 2002; Kang, Khurana, & Wang, 2017), and
corruption and investor protection (Hong, Lee, & Swaminathan, 2003), among others. However,
despite this work the reasons for the existence of profits from momentum strategies and PEAD
remain unclear. Moreover, while the evidence for the anomalies is extensive, it is not found for all
international markets. The potential role of cognitive dissonance in explaining momentum returns is
first proposed by Antoniou et al. (2013). They examine the relationship for the US market, with
empirical results providing support for their hypothesis. In this paper we seek to extend their work to
determine not only whether cognitive dissonance explains the existence of these anomalies, but also
if it accounts for differences across countries, by examining the interaction between culture and
sentiment and how it impacts on investor behavior.
There is general agreement that momentum strategies are profitable in many western markets (see,
e.g., Jegadeesh and Titman (1993), Antoniou et al. (2013) for the United States, Rouwenhorst (1998) for
12 European countries, and Griffin, Ji, and Martin (2003) and Chui et al. (2010) for 40 and 41 markets
worldwide, respectively, with both including the United States, Canada, and a wide range of western
European markets). However, the same is not true for East and South East Asian (henceforth ESEA)
1
See, for example, Liu, Strong, and Xu (2003), Hung, Li, and Wang (2014), and Dou, Truong, and Veeraraghavan (2015)
in relation to PEAD and Antoniou, Doukas, and Subrahmanyam (2013), Forner and Marhuenda (2003), and Wang and Xu
(2015) in relation to returns momentum.
2
When we refer to momentum profits we mean price or returns momentum, in line with prior literature. Some prior studies
examining post-earnings-announcement-drift use the term earnings momentum. For example, Dou et al. (2015) use the
terms earnings momentum and PEAD interchangeably. However, for reasons set out in our hypotheses development we
distinguish between earnings momentum (profits resulting from zero-investment portfolios) and PEAD (where we do not
examine zero-investment portfolios). Rather, we treat significant positive (negative) returns in the period following good
(bad) news as PEAD. Significant returns in the opposite direction are referred to as reversal.
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