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Has Momentum Lost Its Momentum?

Last Updated on 10 February, 2024 by Rejaul Karim

In the paper “Has Momentum Lost Its Momentum?” by Debarati Bhattacharya, Wei-Hsien Li, and Gokhan Sonaer, the authors scrutinize the resilience of momentum returns in the US stock market from 1965 to 2012.

Their findings indicate that momentum profits began losing significance in the late 1990s, with a considerable increase in volatility over the last 14 years. The study delves into the role of high and low volatility months, dissecting whether heightened market volatility contributes to the dwindling profitability of the momentum strategy.

The authors reveal that past returns no longer adequately predict cross-sectional stock return variations and suggest investors might now be trading in ways that eliminate potential momentum profits.

This research seeks to explain the decline in momentum profits through three possible explanations: investors uncovering the anomaly, a decrease in risk premium on macroeconomic factors, and an improvement in market efficiency. The paper adds vital insights to the current understanding of momentum, market efficiency, and asset pricing.

Abstract Of Paper

We evaluate the robustness of momentum returns in the US stock market over the period 1965 to 2012. We find that momentum profits have become insignificant since the late 1990s partially driven by pronounced increase in the volatility of momentum profits in the last 14 years. Investigations of momentum profits in high and low volatility months address the concerns about unprecedented levels of market volatility in this period rendering momentum strategy unprofitable. Past returns, can no longer explain the cross-sectional variation in stock returns, even following up markets. Investigation of post holding period returns of momentum portfolios and risk adjusted buy and hold returns of stocks in momentum suggests that investors possibly recognize that momentum strategy is profitable and trade in ways that arbitrage away such profits. These findings are partially consistent with Schwert (2003) that documents two primary reasons for the disappearance of an anomaly in the behavior of asset prices, first, sample selection bias, and second, uncovering of anomaly by investors who trade in the assets to arbitrage it away. In further analyses we find evidence that suggest three possible explanations for the declining momentum profits that involve uncovering of the anomaly by investors, decline in the risk premium on a macroeconomic factor, growth rate in industrial production in particular and relative improvement in market efficiency.

Original paper – Download PDF

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Author

Debarati Bhattacharya
Duquesne University

Wei-Hsien Li
National Central University

Gokhan Sonaer
Duquesne University

Conclusion

In conclusion, the study “Has Momentum Lost Its Momentum?” by Debarati Bhattacharya, Wei-Hsien Li, and Gokhan Sonaer provides a comprehensive analysis of the robustness of momentum returns in the US stock market between 1965 and 2012.

The findings reveal a marked decline in momentum profits since the late 1990s, with increased volatility in recent years playing a significant role. Furthermore, the research highlights that past returns no longer provide adequate explanatory power for stock return variations, signaling a possible shift in investors’ strategies.

Partially aligning with Schwert (2003), the study suggests three potential drivers for diminishing momentum profits: uncovering of the anomaly by investors, reduced risk premium on macroeconomic factors, and improved market efficiency.

This research sheds light on the evolving landscape of momentum, market efficiency, and asset pricing, contributing valuable knowledge for scholars and practitioners alike.

Related Reading:

Size and Momentum Profitability in International Stock Markets

Cross-Country Composite Momentum

FAQ

Q1: What is the main observation regarding momentum profits in the US stock market according to the research?

The research finds that momentum profits in the US stock market have become insignificant since the late 1990s. This decline is attributed, in part, to a pronounced increase in the volatility of momentum profits over the last 14 years.

Q2: How does the study address concerns about market volatility impacting the profitability of the momentum strategy?

The study investigates momentum profits during high and low volatility months to assess whether unprecedented levels of market volatility in recent years contribute to the diminishing profitability of the momentum strategy. The findings provide insights into the role of market volatility in the observed trends.

Q3: What are the possible explanations provided by the authors for the decline in momentum profits, and how do they align with previous research?

The authors suggest three potential explanations for the declining momentum profits: uncovering of the anomaly by investors, a decrease in the risk premium on macroeconomic factors (specifically the growth rate in industrial production), and relative improvement in market efficiency. These explanations align with previous research, particularly Schwert (2003), which identified sample selection bias and investor recognition as factors contributing to the disappearance of anomalies in asset prices.

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