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A Critique of Momentum Anomalies | an Overview

Last Updated on 10 February, 2024 by Rejaul Karim

In “A Critique of Momentum Anomalies,” Thiago de Oliveira Souza presents a compelling examination of the assumption that stable economic relations exist between specific “firm characteristics” and expected returns.

This paper, the second in a series of critiques, delves into the intricacies of past returns and offers theoretical, empirical, and simulated evidence to support the contention that momentum anomalies align with traditional risk-based asset pricing. The author addresses the theoretical puzzle by demonstrating how riskier assets tend to populate the loser portfolio following significant increases in the price of risk.

Moreover, the paper elucidates the dynamic correlation between past returns and risk, highlighting its impact on the risk of momentum portfolios. Notably, the premiums associated with these portfolios are depicted as negative quadratic functions of the price of risk, thereby resolving the apparent theoretical conundrum.

With a focus on momentum, risk, puzzle, ranking, and conditional aspects, this paper provides a thought-provoking analysis that challenges conventional assumptions and offers new insights into asset pricing dynamics.

Abstract Of Paper

This paper is the second in a series of critiques of the assumption that stable economic relations exist between certain “firm characteristics” and expected returns. The paper explains why this is not the case for past returns and provides theoretical, empirical, and simulated evidence that the stylized facts involving momentum are consistent with traditional risk-based asset pricing, thereby solving the apparent theoretical puzzle. For example, riskier assets tend to be in the loser portfolio after (large) increases in the price of risk: The time-varying correlation between past returns and risk, which determines the risk of momentum portfolios, decreases with the price of risk. Hence, their premiums are approximately negative quadratic functions of the price of risk, theoretically truncated at zero. The best linear (CAPM) function describing this relation unconditionally has the negative slope and positive intercept documented empirically and considered the main momentum puzzle.

Original paper – Download PDF

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Author

Thiago de Oliveira Souza
University of Southern Denmark; affiliation not provided to SSRN

Conclusion

In conclusion, Thiago de Oliveira Souza’s “A Critique of Momentum Anomalies” challenges the conventional assumption that stable economic relations exist between specific “firm characteristics” and expected returns. Through theoretical, empirical, and simulated evidence, the paper demonstrates that past returns do not align with this assumption.

Instead, the stylized facts involving momentum are consistent with traditional risk-based asset pricing. The paper provides a compelling explanation of why riskier assets tend to populate the loser portfolio following significant increases in the price of risk.

Furthermore, the dynamic correlation between past returns and risk plays a crucial role in determining the risk of momentum portfolios. The premiums associated with these portfolios are depicted as negative quadratic functions of the price of risk, theoretically truncated at zero.

The paper’s findings offer new insights into asset pricing dynamics and provide a thought-provoking analysis that challenges conventional assumptions. Overall, this paper provides a valuable contribution to the field of finance and investment.

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Measuring Skewness Premia

FAQ

What is the main focus of the research paper “A Critique of Momentum Anomalies” by Thiago de Oliveira Souza?

The research paper is the second in a series of critiques challenging the assumption that stable economic relations exist between specific “firm characteristics” and expected returns. It specifically focuses on past returns and provides theoretical, empirical, and simulated evidence to argue that momentum anomalies align with traditional risk-based asset pricing.

What theoretical puzzle does the paper address, and how does it resolve it in the context of momentum anomalies?

The paper addresses the theoretical puzzle related to the assumption that stable economic relations exist between firm characteristics and expected returns, particularly for past returns. It offers theoretical, empirical, and simulated evidence to demonstrate that the stylized facts involving momentum are consistent with traditional risk-based asset pricing. The author explains how riskier assets tend to populate the loser portfolio following significant increases in the price of risk, resolving the apparent theoretical conundrum.

How does the paper explain the dynamic correlation between past returns and risk, and what role does it play in determining the risk of momentum portfolios?

The paper explains that the dynamic correlation between past returns and risk is a crucial factor in determining the risk of momentum portfolios. The time-varying correlation between past returns and risk decreases with the price of risk. This dynamic correlation influences the risk of momentum portfolios, providing insights into how riskier assets are included in the loser portfolio after substantial increases in the price of risk.

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