Momentum is Not an Anomaly
46 Pages Posted: 4 Nov 2007
Date Written: October 2007
In this paper, we develop a new approach to test whether momentum is indeed an anomaly in that it reflects delayed reactions, or continued overreactions, to firm specific news. Our methodology does not depend on a specific model of expected returns and, more importantly, does not require a decomposition of momentum profits. Yet we provide distinct testable predictions that can discriminate between the two diametrically opposed causes for the profitability of momentum strategies: time-series continuation in the firm-specific component of returns, and cross-sectional differences in expected returns and systematic risks of individual securities. Our results show that, contrary to the common belief in the profession, momentum is not an anomaly; we find no evidence of continuation in the idiosyncratic component of individual-security returns. The evidence is instead consistent with momentum being driven entirely by cross-sectional differences in expected returns and risks of individual securities.
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