Investigating the source of momentum profits: Risk factors or market inefficiencies?
This dissertation consists of three short essays. The first chapter, entitled "Industries Do Not Explain Momentum", examines the role industry membership plays in the success of momentum strategies. Contrary to the two major conclusions of Moskowitz and Grinblatt (1999), namely industry momentum earns significant profit during the first month of the holding period and the profits from individual stock momentum strategies can be largely explained by the industry momentum, industry is not an important effect. In particular, the strength of the industry momentum depends heavily on the choice of sample period and has become progressively weaker through time. Over the entire sample period of 07/63-07/97, the average four week holding return of the industry momentum strategy is not statistically different from zero. If we exclude the effects of industries when classifying winners/losers, the individual stock momentum strategy still earns highly significant profits. The second chapter, entitled "Momentum and Market Delayed Overreaction", investigates whether empirical evidence supports the conjecture that the momentum effect is caused by market inefficiencies related to investor overconfidence. By sorting winner/loser stocks based on characteristics like the book-to-market ratio and volatility over the formation period, it appears the momentum effect is consistent with the market "delayed overreaction" type behavioral explanation of Daniel, Hirshleifer and Subrahmanyam (1998). In the third chapter, "Momentum and Earnings Uncertainty", we find that the dispersion of analyst earnings estimates for the next fiscal year seems to have strong unconditional predictive power on the cross-sectional returns. Furthermore, this unconditional earnings uncertainty effect may help to explain part of the momentum profits.
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