A Model of Momentum
55 Pages Posted: 7 Mar 2011 Last revised: 27 Feb 2012
Date Written: November 13, 2011
We offer an investment-based interpretation of price and earnings momentum. The neoclassical theory of investment implies that expected stock returns are tied with the expected marginal benefit of investment divided by the marginal cost of investment. Winners have higher expected growth and expected marginal productivity (two major components of the marginal benefit of investment), and earn higher expected stock returns than losers. The investment model succeeds in capturing average momentum profits, reversal of momentum in long horizons, as well as the interaction of momentum with size, firm age, trading volume, stock return volatility, credit ratings, and book-to-market. However, the model fails to reproduce procyclical momentum profits.
Keywords: Price Momentum, Earnings Momentum, GMM, Expected Growth, Investment
JEL Classification: E22, E44, G12, G14, G31
Suggested Citation: Suggested Citation