Momentum Redux

Momentum is being discovered in the blogosphere, once again. Hazah.

The finance literature includes a tradition of momentum, going back to early 1990s. Preceding academic treatment, momentum has been a staple of technical analysis for many decades. Prominent academic authors include Jegadeesh, Titman, Asness (grad student of Fama and French), Rouwenhorst, Moskowitz, and Hong. An abridged review of this literature may be perhaps useful, as substantive econometric effort has been invested in analysis spanning both time and asset class.

Two studies are often credited with validating momentum within the academic community, the first via JoF publication and the second through implicit endorsement of FF:

• Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency, Jegadeesh and Titman (1993)
• Variables that Explain Stock Returns: Simulated and Empirical Evidence, Asness (1994)

Subsequent literature has demonstrated cross-sectional efficacy across markets, asset classes, and time:

• S&P Style: Style Momentum Within the S&P 500 Index (Chen and De Bondt; 2004) and Cross-Asset Style Momentum (Kim; 2010)
• Industry / Sector: Do Industries Explain Momentum?, Moskowitz and Grinblatt (1999)
• Smallcap (ex-micro): Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies, Hong et al (1999)
• European Equities: International Momentum Strategies, Rouwenhorst (1997)
• UK: The Profitability of Momentum Investing, by Lui et al (1999)
• China: Contrarian and momentum strategies in the China stock market: 1993-2000, Kang et al (2002)
• Japan: Momentum in Japan: The Exception that Proves the Rule, Asness (2011)
• Emerging Equities: Local Return Factors and Turnover in Emerging Stock Markets, Rouwenhorst (1999)
• Global Equities: Momentum Investing and Business Cycle Risk: Evidence from Pole to Pole, Griffin et al (2002)
• FX: Do Momentum Based Strategies Still Work In Foreign Currency Markets? (Okunev and White, 2003), Interaction between Technical Currency Trading and Exchange Rate Fluctuations (Schulmeister, 2006), Momentum in Stock Market Returns: Implications for Risk Premia on Foreign Currencies (Nitschka, 2010), and Currency Momentum Strategies (Menkhoff et al, 2011)
• Commodities: Momentum strategies in commodity futures markets, Miffre and Rallis (2007)
• Cross-Asset: Parallels Between the Cross-sectional Predictability of Stock and Country Returns (Asness et al, 1997), Global Tactical Cross-Asset Allocation: Applying Value and Momentum Across Asset Classes (Blitz and Van Vliet; 2007), and Momentum and Value Everywhere (Asness, Moskowitz, and Pedersen; 2009)
• Inter-Asset: Macromomentum: Returns Predictability in International Equity Indices, Bhojraj (2006)

Even 52-week highs, a perennial favorite of technical analysts, are shown to possess relationship with momentum in 52-Week High and Momentum Investing (George and Hwang, 2004). Similarly, Momentum Strategies demonstrates evidence of relationship with both price and earnings momentum (Chan et al, 2006).

Time-series efficacy has been demonstrated in Market States and Momentum (Gutierrez et al, 2003), Time-Varying Momentum Profitability (Wang and Xu, 2010), and Time Series Momentum (Moskowitz et al, 2011).

The literature has offered many proposed explanations for both efficacy and durability of momentum. Modern opinion is behavioral (essentially cognitive bias), with arguably the leading contender being time-dynamic interplay of investor underreaction and overreaction (aka investor sentiment and informational efficiency), possibly signaled via trading volume:

• When are Contrarian Profits Due to Stock Market Overreaction?, Lo and Mackinlay (1990)
• A Model of Investor Sentiment, Barberis, Shleifer, Vishny (1997)
• A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets, Hong and Stein (1997)
• Investor Psychology and Security Market Under- and Over-Reactions, Daniel, Hirshleifer, Subrahmanyam (1998)
• Price Momentum and Trading Volume, Lee and Swaminathan (1998)
• Underreactions and Overreactions: The Influence of Information Reliability and Portfolio Formation Rules, Bloomfield et al (1998)
• Momentum – Reversal Strategy, Yu and Chen (2011)

Other proposed explanations include:

• Excess Covariance: Momentum and Autocorrelation in Stock Returns, Lewellen (2002)
• Tax Loss Harvesting: Predicting Stock Price Movements from Past Returns: The Role of Consistency and Tax-Loss Selling, Grinblatt and Moskowitz (2004)
• Prospect Theory / Disposition Effect: Prospect Theory, Mental Accounting, and Momentum (Han and Grinblatt; 2004) and The Disposition Effect and Underreaction to News (Frazzini; 2006)
• Cross-sectional Expected Returns: Momentum is Not an Anomaly, Dittmar et al (2007)
• Informed trading: Momentum and Informed Trading, Hameed et al (2008)
• Sentiment: Sentiment and Momentum, Doukas et al (2010)

The above literature is framed within the larger context of the long-standing EMH factors/anomalies debate, which was stoked by:

• The Cross-Section of Expected Stock Returns, Fama and French (1992)
• Contrarian Investment Extrapolation and Risk, Lakonishok, Shleifer, and Vishny (1994)
• On Persistence in Mutual Fund Performance, Carhart (1997)

This literature was retrospectively surveyed in Dissecting Anomalies, Fama and French (2008).

This context explains why momentum is often conflated with other factors / tilts, most commonly value. For example, Asness is a long-standing proponent of value / momentum combo, due to negative portfolio correlation. Relevant literature:

• The Interaction of Value and Momentum Strategies, Asness (1998)
• Global Tactical Cross-Asset Allocation: Applying Value and Momentum Across Asset Classes, Blitz and Van Vliet (2008)
• Applying Value and Momentum Across Asset Classes in a Quantitative Tactical Asset Allocation Framework, Wang (2011)
• Size, Value, and Momentum in International Stock Returns, Fama and French (2011)

In recognizing these interrelationships, we indeed come back full circle to minimum variance and portfolio theory by recalling that value is proposed as a proxy factor for minvar. Perhaps the world is small after all?

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