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Momentum Redux

June 18, 2011

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:

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

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:

Other proposed explanations include:

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

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:

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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