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Cross-Sectional Factor Dynamics and Momentum Returns

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Cross-Sectional Factor Dynamics and Momentum Returns” by Doron Avramov and Satadru Hore presents an innovative inter-temporal model, which explores the co-movements of aggregate consumption and asset-specific dividend growths alongside two mean-reverting state variables.

The model reveals that consumption beta experiences temporal and cross-sectional variation due to differences in half-lives and stationary volatilities of dividend signals. Winner stocks exhibit high half-lives and stationary volatilities, whereas loser stocks display low values for these metrics, leading to diverse consumption betas and risk premiums.

Additionally, the study provides a rational basis for the “momentum crashes” phenomenon, as articulated by Daniel and Moskowitz (2014). The model demonstrates that, after recovering from an economic downturn, the consumption betas of winners and losers diverge, subsequently impacting the risk-premia of the long winner/short loser strategy.

The paper makes significant strides in unraveling the complexities of momentum returns and their linkages with cross-sectional factor dynamics.

Abstract Of Paper

This paper proposes and implements an inter-temporal model wherein aggregate consumption and asset-specific dividend growths jointly move with two mean-reverting state variables. Consumption beta varies through time and cross sectionally due to variation in half-lives and stationary volatilities of the dividend signals. Winner (Loser) stocks exhibit high (low) half-lives and stationary volatilities, and thus exhibit high (low) consumption beta commanding high (low) risk-premium. The model also rationalizes the \”momentum crashes\” phenomenon discussed in Daniel and Moskowitz (2014). High half-lives of dividend signals in Winners keep their consumption betas low long after recovering from a prolonged economic downturn, while low half-lives in Losers make their consumption betas grow rather quickly. Thus, coming out of a recession, the long Winner/short Loser strategy reduces in consumption beta and, hence, risk-premia.

Original paper – Download PDF

Here you can download the PDF and original paper of Cross-Sectional Factor Dynamics and Momentum Returns.

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Author

Doron Avramov
Reichman University – Interdisciplinary Center (IDC) Herzliyah

Satadru Hore
Federal Reserve Bank of Boston

Conclusion

In summary, the research paper “Cross-Sectional Factor Dynamics and Momentum Returns” by Doron Avramov and Satadru Hore unveils a groundbreaking inter-temporal model that dissects the intricate interplay between aggregate consumption, asset-specific dividend growths, and mean-reverting state variables.

The study highlights the drivers behind the temporal and cross-sectional variations of consumption beta, attributing these dynamics to fluctuations in half-lives and stationary volatilities of dividend signals.

The model effectively explains the “momentum crashes” phenomenon while illustrating the distinct characteristics of winner and loser stocks. Furthermore, it exemplifies the impact of economic downturn recovery on consumption beta and risk-premia in the long winner/short loser strategy.

The valuable insights offered in this paper enhance the understanding of momentum returns, long-run risk, cross-sectional dynamics, and their profound implications on numerous facets of the financial markets.

Related Reading:

Momentum in Imperial Russia

Trading Strategies Based on Past Returns – Evidence from Germany

FAQ

Q1: How does the inter-temporal model in the paper explain the variation in consumption beta for winner and loser stocks in momentum strategies?

The model attributes the temporal and cross-sectional variations in consumption beta to differences in half-lives and stationary volatilities of dividend signals. Winner stocks exhibit high half-lives and stationary volatilities, resulting in high consumption beta and risk premiums. In contrast, loser stocks display low values for these metrics, leading to low consumption beta and risk premiums.

Q2: How does the paper rationalize the “momentum crashes” phenomenon discussed by Daniel and Moskowitz (2014)?

The model provides a rational basis for “momentum crashes” by illustrating the impact of economic downturn recovery on winner and loser stocks. Winner stocks maintain low consumption beta long after a recession due to high half-lives of dividend signals. On the other hand, loser stocks experience a quick growth in consumption beta. As a result, the long winner/short loser strategy sees a reduction in consumption beta and risk-premia during the recovery phase.

Q3: What are the key contributions of the paper to the understanding of momentum returns?

The paper introduces an innovative inter-temporal model that dissects the co-movements of aggregate consumption, asset-specific dividend growths, and mean-reverting state variables. It offers insights into the dynamics of consumption beta for winner and loser stocks, providing a nuanced understanding of the factors influencing risk premiums in momentum strategies. The rationalization of “momentum crashes” contributes to the broader comprehension of momentum returns and their links to economic conditions.

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