Anatomy of risk and reward in stock market momentum strategies
It is well established that recent prior winner and loser stocks exhibit return continuation; a momentum strategy of buying recent winners and shorting recent losers appears profitable in the post-1945 era. In contrast, the risk exposure of such strategies has not been well understood; extant analyses concentrated on the strategies' average risk exposures over time are deceptive. The stock selection method used by momentum strategies guarantees that large and time varying factor exposures will be borne in accordance with the performance of the common risk factors during the periods in which stocks were ranked to determine their winner or loser status. Because the factors themselves display trivial momentum, extreme factor realizations are in effect producing noise which obscures the study of the momentum phenomenon. This noise is penetrated in two ways. First, measurements of the factor exposure of momentum strategies are made during both formation and investment periods. Raw returns to the strategies are adjusted for factor risk with two striking results: the momentum phenomenon is remarkably stable across subperiods in the entire time series of stock returns from 1926; and factor models can explain over ninety-five percent of the variability of winner or loser returns, but can only partially explain their mean returns. Second, alternative momentum strategies are studied which base winner or loser status on stock-specific return components over some ranking period. Such strategies are more profitable than those based on total returns. Evidence is also presented that neither industry effects nor cross-sectional differences in expected returns are the primary cause of the observed momentum phenomenon.
|Year of publication:||
|Authors:||Martin, James Spencer|
|Type of publication:||Other|
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