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Buy-Side Competition and Momentum Profits | Overview

Last Updated on 10 February, 2024 by Rejaul Karim

The article in the Review of Financial Studies, titled “Buy-Side Competition and Momentum Profits,” by Gerard Hoberg, Nitin Kumar, and Nagpurnanand Prabhala, explores the influence of buy-side competition on momentum profits. The authors present a new measure of buy-side competition and reveal that the momentum quintile spread is 1.11% when competition is low and negligible when competition is high.

The study demonstrates that improved alphas can be achieved with superior Sharpe and Sortino ratios, no negative skewness, and in investable strategies featuring value-weighted portfolios and large-cap stocks. Traditional stock characteristics related to momentum do not account for these results.

Furthermore, the research employs tests based on long-term reversals, trading patterns of funds, their style peers, distant funds, and retail investors, suggesting that slow information diffusion is responsible for the substantial momentum spreads and reversals in low competition markets.

This compelling investigation sheds light on the relationship between buy-side competition and momentum profits, offering valuable insights for market efficiency and return predictability.

Abstract Of Paper

We show that a new measure of buy-side competition explains momentum profits. The momentum quintile spread is 1.11% when competition is low and negligible when competition is high. Better alphas are attained with superior Sharpe and Sortino ratios, no negative skewness and in more investible strategies featuring value-weighted portfolios and large capitalization stocks. Stock characteristics traditionally related to momentum do not explain our results. Tests based on long-term reversals, the trading patterns of funds, their style peers, distant funds, and retail investors suggest that slow information diffusion explains the large momentum spreads and momentum reversals in low competition markets.

Original paper – Download PDF

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Author

Gerard Hoberg
University of Southern California – Marshall School of Business – Finance and Business Economics Department

Nitin Kumar
Indian School of Business (ISB), Hyderabad

Nagpurnanand Prabhala
The Johns Hopkins Carey Business School

Conclusion

In conclusion, the forthcoming article in the Review of Financial Studies, titled “Buy-Side Competition and Momentum Profits” by Gerard Hoberg, Nitin Kumar, and Nagpurnanand Prabhala, presents significant evidence that a new measure of buy-side competition plays a crucial role in explaining momentum profits.

The study uncovers that the momentum quintile spread stands at 1.11% in low competition markets and becomes negligible in high competition markets. Furthermore, the authors demonstrate that enhanced alphas are achieved in investable strategies with superior Sharpe and Sortino ratios, no negative skewness, value-weighted portfolios, and large-cap stocks. Interestingly, traditional stock characteristics related to momentum are insufficient to explain these findings.

The analysis also suggests that slow information diffusion is the primary driving force behind the substantial momentum spreads and reversals in low competition markets. This insightful research has important implications for understanding the connection between buy-side competition, momentum profits, market efficiency, and return predictability.

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FAQ

Q1: What is the main focus of the article “Buy-Side Competition and Momentum Profits” by Gerard Hoberg, Nitin Kumar, and Nagpurnanand Prabhala?

The article explores the relationship between buy-side competition and momentum profits. The authors introduce a new measure of buy-side competition and demonstrate its influence on momentum quintile spreads, revealing substantial profits when competition is low and negligible profits when competition is high.

Q2: What distinguishes the enhanced alphas achieved in low competition markets, and how are they related to investable strategies?

The study shows that improved alphas in low competition markets are associated with superior Sharpe and Sortino ratios, no negative skewness, and investable strategies featuring value-weighted portfolios and large-capitalization stocks. Traditional stock characteristics related to momentum do not account for these results.

Q3: What does the research suggest regarding the driving force behind substantial momentum spreads and reversals in low competition markets?

Based on tests related to long-term reversals, trading patterns of funds, style peers, distant funds, and retail investors, the research suggests that slow information diffusion is the primary factor responsible for the significant momentum spreads and reversals observed in low competition markets. This finding has important implications for understanding market efficiency and return predictability.

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