Investors’ trading on past returns and their trading impact on stock returns

This paper extends the return-volume literature by examining the dynamic, bidirectional implications of seven largely unexplored trading theories: analyst optimism, social interaction, style trading, investor disagreement, and investor attention (both firm-specific and market-specific for the latter two). Following Chordia et al. (2011), we use firm-level data to capture heterogeneity that market-index data may obscure. Our main findings are as follows. First, return-volume relations exhibit substantial heterogeneity in both directions. Second, investors trade more actively following high returns at the stock, style, and market levels and respond more aggressively to positive returns than to negative ones. Third, investor sentiment amplifies these patterns: trading on past high returns is more frequent during high-sentiment periods. Finally, we introduce a novel decomposition of trading volume into three past return-driven components, which exert upward price pressure on the traded stocks. Stocks subject to greater price pressure tend to be overpriced. These results provide empirical support for the theories of analyst optimism, style trading, firm-specific disagreement, and firm-specific attention. JEL classification: C32, G12