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The Vanishing Abnormal Returns of Momentum Strategies and ‘Front-Running’ Momentum Strategies

Last Updated on 10 February, 2024 by Rejaul Karim

The Vanishing Abnormal Returns of Momentum Strategies and ‘Front-Running’ Momentum Strategies,” a research paper by Thomas Henker, Martin Martens, and Robert Huynh, investigates the varying returns of momentum strategies, particularly between 1993-2004, when they did not yield significant returns due to poor performance during 2001-2004.

The study also explores the large firm momentum effect, finding it to be sensitive to the particular momentum strategy examined and driven by abnormal returns in large Nasdaq stocks. In addition, the paper evaluates alternate momentum strategies that deviate from conventional end-of-month portfolio formations, by forming “front-running” momentum portfolios one week ahead of the month-end.

The findings suggest that these ‘front-running’ strategies generate similar yet less volatile returns compared to month-end strategies, indicating the potential influence of institutional momentum trading on month-end returns and volatility.

Abstract Of Paper

We find large variations in returns from momentum strategies. Momentum strategies did not earn significant returns during the period of 1993-2004 which was due to their poor performance over the period from 2001-2004. We find that the previously documented large firm momentum effect is sensitive to the momentum strategy examined, and is in our sample driven by the abnormal returns of large Nasdaq stocks. We also evaluate momentum strategies that do not adhere to the end of month portfolio formation universally used in the academic literature. To this end we form portfolios one week prior to the end of month and call them ‘front-running’ momentum portfolios. Consistent with institutional momentum trading affecting end of month returns and volatility, we find that ‘front-running’ a momentum strategy generates similar, but less volatile returns than the month-end strategy. Pertinently, the returns of a ‘front-running’ strategy are consistently less volatile than that of an equivalent month-end strategy.

Original paper – Download PDF

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Author

Thomas Henker
Bond University

Martin Martens
Robeco Asset Management

Robert Huynh
UNSW Australia Business School, School of Banking and Finance

Conclusion

In conclusion, the research paper “The Vanishing Abnormal Returns of Momentum Strategies and ‘Front-Running’ Momentum Strategies” by Thomas Henker, Martin Martens, and Robert Huynh uncovers the substantial fluctuations in momentum strategy returns, particularly the non-significant returns generated during the 1993-2004 period, due to weak performance from 2001-2004.

The study shows that the large firm momentum effect is sensitive to the specific momentum strategy utilized and is influenced by large Nasdaq stocks’ abnormal returns.

Furthermore, by examining “front-running” momentum portfolios formed one week prior to the month-end, the research highlights that such strategies generate similar, yet less volatile returns compared to conventional month-end approaches and sheds light on the potential impact of institutional momentum trading on returns and volatility.

This study substantially contributes to the understanding of momentum strategy returns and their variability, providing valuable insights for investors and financial professionals.

Related Reading:

Momentum Has Its Moments

Momentum, Risk, and Underreaction

FAQ

Q1: What are the key findings regarding momentum strategy returns, and why did momentum strategies exhibit non-significant returns during the 1993-2004 period?

The study reveals significant variations in momentum strategy returns and highlights that momentum strategies did not yield significant returns from 1993 to 2004, primarily due to poor performance during the period from 2001 to 2004. This suggests that the efficacy of momentum strategies can be influenced by specific timeframes and market conditions.

Q2: How does the large firm momentum effect vary, and what role do large Nasdaq stocks play in this context?

The research emphasizes the sensitivity of the large firm momentum effect to the chosen momentum strategy. It further identifies that the effect is driven by abnormal returns in large Nasdaq stocks. Understanding the nuances of the large firm momentum effect contributes to a more comprehensive view of momentum strategy dynamics.

Q3: What insights does the study provide into the impact of ‘front-running’ momentum strategies, and how do they compare to conventional month-end strategies?

The study introduces the concept of “front-running” momentum portfolios formed one week prior to the month-end and demonstrates that these strategies generate similar returns to conventional month-end strategies. Notably, the ‘front-running’ approach exhibits less volatility, suggesting a potential influence of institutional momentum trading on returns and volatility. This insight may have implications for investors seeking to optimize their momentum strategies.

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