Explaining Momentum Strategies Using Intrinsic Price Fluctuations

This paper focuses on cross-sectional equity momentum patterns by modeling a stock's price path as the interaction between a long-term growth component and a number of fluctuating price components that oscillate around the long-term trend at various distinct frequencies. Using this specification, the results are consistent with a behavioural overreaction-to-private-information and underreaction-to- public-information explanation of cross-sectional explanation of momentum patterns. Cross-sectional momentum profitability is found to be robust to realistic transaction costs and a 6-month holding period appears to be the optimal tradeoff investment horizon between the short-term and the longer-term effect of the transaction costs. Simple stop-loss rules are shown to improve the performance of strategies with long-term holding horizon by discarding big and growth stocks, which achieve higher levels of price efficiency and therefore realise their momentum potential faster than small and value stocks