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Factor Momentum and the Dynamics of the Momentum Factor

Last Updated on 10 February, 2024 by Rejaul Karim

Unveiling the intricate layers of financial dynamics, “Factor Momentum and the Momentum Factor” by Sina Ehsani and Juhani T. Linnainmaa, hailing from Northern Illinois University and Dartmouth College, navigates through the symbiotic relationship between momentum in individual stock returns and factor returns.

Published on August 7, 2017, and revised on March 20, 2021, this exploration delves into the realm of factor momentum, exposing a fascinating interplay where most factors exhibit positive autocorrelation. Factors tend to earn returns of 6 basis points after a year of losses and 51 basis points following a positive year.

Remarkably, this momentum concentration aligns with factors that wield greater influence over the cross section of returns, challenging the notion that momentum is merely an incidental facet of individual stock momentum. The study delves into the essence of momentum-neutral factors, revealing a richer momentum presence.

Notably, momentum in high-eigenvalue PC factors encompasses all forms of individual stock momentum, underscoring momentum’s role as a temporal influencer on various factors rather than a standalone risk factor.

Abstract Of Paper

Momentum in individual stock returns emanates from momentum in factor returns. Most factors are positively autocorrelated: the average factor earns a monthly return of 6 basis points following a year of losses and 51 basis points following a positive year. We find that factor momentum concentrates in factors that explain more of the cross section of returns and that it is not incidental to individual stock momentum: momentum-neutral factors display more momentum. Momentum found in high-eigenvalue PC factors subsumes all forms of individual stock momentum. Our results suggest that momentum is not a distinct risk factor; it times other factors.

Original paper – Download PDF

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Author

Sina Ehsani
Northern Illinois University

Juhani T. Linnainmaa
Dartmouth College – Tuck School of Business; National Bureau of Economic Research (NBER); Kepos Capital

Conclusion

In summary, the study delving into factor momentum sheds light on the interconnectedness of individual stock returns and factor dynamics. Factor momentum, driven by positive autocorrelation, concentrates in factors wielding significant explanatory influence.

Contrary to conventional wisdom, momentum-neutral factors exhibit heightened momentum. Crucially, high-eigenvalue PC factors eclipse individual stock momentum. This challenges the idea of momentum as a standalone risk factor, portraying it as a skillful influencer of other underlying factors. This nuanced perspective enhances our comprehension of market anomalies.

Related Reading:

Return Chasing and Trend Following: Superficial Similarities Mask Fundamental Differences

Uncovering Trend Rules

FAQ

Q1: What is the primary focus of the paper “Factor Momentum and the Momentum Factor,” and what does it reveal about the relationship between momentum in individual stock returns and factor returns?

The paper explores the relationship between momentum in individual stock returns and factor returns, specifically delving into the concept of factor momentum. It reveals that momentum in individual stock returns emanates from momentum in factor returns, highlighting a symbiotic relationship between the two. The study uncovers positive autocorrelation in most factors, with factors earning returns of 6 basis points after a year of losses and 51 basis points following a positive year.

Q2: How does factor momentum concentrate, and what surprising findings challenge traditional notions about momentum and its relationship with factors?

Factor momentum tends to concentrate in factors that have a greater explanatory influence on the cross section of returns. Contrary to conventional wisdom, momentum-neutral factors display more momentum. The study challenges the notion that momentum is merely an incidental facet of individual stock momentum and reveals that high-eigenvalue principal component factors encompass all forms of individual stock momentum. This challenges the idea of momentum as a distinct risk factor, portraying it as an influencer of other underlying factors.

Q3: What is the key takeaway regarding momentum’s role in influencing other factors, and how does this perspective contribute to our understanding of market anomalies?

The study suggests that momentum is not a distinct risk factor but rather a temporal influencer on other factors. The results indicate that momentum’s presence is more than just a standalone risk factor; it times other factors. This nuanced perspective enhances our understanding of market anomalies by emphasizing the interconnectedness of individual stock returns and factor dynamics.

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