Decomposing Momentum

Abstract

We decompose the momentum profits based on total stock returns into three components: a long-term average alpha component that reverses, a stock beta component that accounts for the dynamic market exposure (and momentum crash risk), and a residual return component that drives the momentum effect (and subsumes total-return momentum). The variation in total-return momentum across market states and business cycles is attributable to the time-varying performance of the long-term reversal component, while residual-return momentum is invariant over time. Hence, we establish a dichotomy between intermediate-term momentum and long-term reversal: stocks that experience momentum are different from the ones that reverse.