Explaining Momentum Strategies Using Intrinsic Price Fluctuations
UBS AG; Imperial College Business School
December 6, 2011
24th Australasian Finance and Banking Conference 2011 Paper
This paper focuses on cross-sectional equity momentum patterns by modeling a stock’s price path as the interaction between a long-term growth component and a number of fluctuating price components that oscillate around the long-term trend at various distinct frequencies. Using this specification, the results are consistent with a behavioural overreaction-to-private-information and underreaction-to- public-information explanation of cross-sectional explanation of momentum patterns. Cross-sectional momentum profitability is found to be robust to realistic transaction costs and a 6-month holding period appears to be the optimal tradeoff investment horizon between the short-term and the longer-term effect of the transaction costs. Simple stop-loss rules are shown to improve the performance of strategies with long-term holding horizon by discarding big and growth stocks, which achieve higher levels of price efficiency and therefore realise their momentum potential faster than small and value stocks.
Number of Pages in PDF File: 63
Keywords: Momentum, Price Trend, Transaction Costs, Stop-Loss, Empirical Mode Decomposition, Ensemble Empirical Mode Decomposition
JEL Classification: D23, E3, G14working papers series
Date posted: August 27, 2011 ; Last revised: January 7, 2012
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