Profitability of Contrarian and Momentum Strategies and Market Stability

This paper proposes a continuous-time heterogeneous agent model of investor behaviour consisting of fundamentalist, contrarian, momentum and market maker strategies to study their impact on market stability and profitability. The underlying stochastic delay integro-differential equation model provides a unified approach to model different time horizons of momentum and contrarian strategies, which play an important role in the profitability of these strategies empirically. By including noise traders and imposing a stochastic fundamental value, we demonstrate that momentum and contrarian strategies can be consistent with market efficiency and the model is able to replicate various market phenomena and stylized facts. Finally, we demonstrate the activities of different traders can affect their profitability dramatically, which sheds new light in understanding the profitability mechanism.