The "momentum effect" holds that stocks that performed well in the recent past will continue to do so in the near future. Yet this is far from a universal effect. Although momentum profits can be substantial in places such as the U.S., the effect is much weaker in other places, notably East Asia. New research suggests there may be cultural-related factors at play, in particular the degree of individualism.

K.C. John Wei of HKUST and his co-authors Andy C.W. Chui and Sheridan Titman argue individualism has a significant influence on momentum profits because it is associated with over-optimism and over-confidence. Individualism is also associated with a self-attribution bias in which people take credit for success and deny responsibility for failure.

"Earlier research has suggested that people in individualistic cultures are likely to be more overconfident about the precision of their information and more prone to the self-attribution bias than are people in collectivistic cultures. Its also been indicated that overconfidence and self-attribution can generate momentum profits and long-term reversals. We therefore examine whether these return patterns are stronger in individualistic countries than collectivistic ones," the authors say.

They focus specifically on momentum profits, trading volume and volatility, and use the established Hofstede index on individualism to compare scores for 41 countries with the performance of more than 20,000 individual stocks from these countries from 1980-2003.

As predicted, momentum profits increase with the score on the individualism index. The average monthly return for portfolios from countries scoring high on the index in the top third was 1.04 per cent. This was 0.65 per cent higher than those in the lowest third.

The authors also correlate the results with a wide range of other variables to see if these override individualism to explain the stock performance. These variables include such things as the political stability, financial development and degree of insider trading in a country, the volatility of the overall economy as measured by exchange rates, the ratios of market capitalisation and private credit to GDP, the volatility of real GDP growth, the openness of the stock market, the countrys debt ratio, market trading volume and median firm size, the number of analysts following each stock, corruption, investor protection, the presence of large or small firms and other factors that could, possibly, affect momentum profits.

In each case, the effect of individualism remains positive.

"We were unable to come up with plausible determinants of momentum profits that subsume the effect of individualism," the authors say.

They also re-visit the original motivation of their study weak momentum profits in East Asia to see if the global results are driven by that region. Countries in East Asia score low on the individualism index, but even removing them from their sample does not affect the result. Individualism is still positively related to momentum profits.

The authors caution that their findings be viewed more as circumstantial rather than definitive, and further investigation is needed. Nonetheless, their cross-country perspective provides an alternative to the largely U.S data that has been studied.

"Our evidence indicates that culture can have an important effect on stock return patterns, consistent with the idea that investors in different cultures interpret information in different ways and are subject to different biases," they say.

"One interpretation is that in less individualistic cultures, investors put less weight on information they come up with on their own and more weight on the consensus of their peers. In other words, individuals in individualistic cultures act less like the overconfident/self-attribution biased investors described by others, and thus tend not to make investment choices that generate momentum profits."