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Market States and Momentum

Last Updated on 10 February, 2024 by Rejaul Karim

Navigating the intricacies of market dynamics, “Market States and Momentum” by Roberto C. Gutierrez, Michael J. Cooper, and Allaudeen Hameed, unveils a fascinating exploration of overreaction theories within the cross-section of stock returns. This research, posted on February 12, 2002, hails from the University of Oregon, University of Utah, and National University of Singapore (NUS).

The study intricately examines the relationship between momentum profits and the market state, revealing that the profitability of short-run momentum is contingent on market conditions. From 1929 to 1995, monthly momentum profits post positive market returns average 0.93%, contrasting with a negative 0.37% following negative market returns.

Interestingly, up-market momentum experiences a long-run reversal. Robust against macroeconomic factors, the study also dispels their explanatory power for momentum profits after adjusting for microstructure concerns. This research not only sheds light on market intricacies but challenges prevailing theories, probing the profound interplay between market states and stock returns.

Abstract Of Paper

We test overreaction theories of short-run momentum and long-run reversal in the cross section of stock returns. Momentum profits depend on the state of the market, as predicted. From 1929 to 1995, the mean monthly momentum profit following positive market returns is 0.93 percent, whereas the mean profit following negative market returns is negative 0.37 percent. The up-market momentum reverses in the long-run. Our results are robust to the conditioning information in macroeconomic factors. Moreover, we find that macroeconomic factors are unable to explain momentum profits after simple methodological adjustments to take account of microstructure concerns.

Original paper – Download PDF

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Conclusion

In summary, the investigation into market states and momentum reveals compelling insights into the dynamics of short-run momentum and long-run reversal in stock returns. The study aligns with overreaction theories, showcasing that the profitability of momentum strategies is intricately tied to the prevailing market conditions.

Notably, the mean monthly momentum profit displays a dependence on the market’s direction, with positive market returns yielding a mean profit of 0.93 percent, while negative market returns result in a mean profit of negative 0.37 percent from 1929 to 1995. The observed momentum in up-market conditions eventually undergoes reversal in the long run. Importantly, these findings withstand scrutiny even when accounting for macroeconomic factors, emphasizing the robustness of the momentum-profit relationship.

Additionally, macroeconomic factors fall short in explaining momentum profits, even after methodological adjustments for microstructure considerations. This comprehensive analysis underscores the nuanced interplay between market states and the profitability of momentum and contrarian strategies.

Related Reading:

Momentum Crash Management

Momentum Trading, Return Chasing and Predictable Crashes

FAQ

Q1: What is the key relationship explored in “Market States and Momentum” regarding momentum profits and the market state?

The study explores the relationship between momentum profits and the state of the market. It reveals that the profitability of short-run momentum is contingent on market conditions, showcasing a dependence on the direction of the market.

Q2: What are the mean monthly momentum profits based on positive and negative market returns according to the study?

From 1929 to 1995, the mean monthly momentum profit following positive market returns is 0.93 percent, whereas the mean profit following negative market returns is negative 0.37 percent. This highlights the influence of market states on the profitability of momentum strategies.

Q3: Does the study find any evidence of long-run reversal in the context of up-market momentum?

Yes, the study observes that up-market momentum experiences long-run reversal. Despite short-term profitability, the momentum in up-market conditions eventually undergoes reversal in the long run, adding complexity to the dynamics of stock returns.

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