The Momentum Gap and Return Predictability

WFA 2015 Seattle Meetings Paper

53 Pages Posted: 17 Aug 2014 Last revised: 2 Mar 2019

See all articles by Simon Huang

Simon Huang

University of Massachusetts Amherst - Isenberg School of Management

Date Written: February 28, 2019

Abstract

The formation period return difference between past winners and losers, which I call the momentum gap, negatively predicts momentum profits. I document this for the U.S. stock market and find consistent results across 21 major international markets. A one standard deviation increase in the momentum gap predicts a 1.25% decrease in the monthly momentum return after controlling for existing predictors. This predictability extends up to five years for static momentum portfolios, consistent with time-varying investor biases. Following the simple real-time strategy of investing in momentum only when the momentum gap is below the 80th percentile substantially increases its Sharpe ratio.

Keywords: Momentum, return predictability, market efficiency, behavioral finance, asset pricing anomaly

JEL Classification: G10, G12, G14

Suggested Citation

Huang, Simon, The Momentum Gap and Return Predictability (February 28, 2019). WFA 2015 Seattle Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2318858 or http://dx.doi.org/10.2139/ssrn.2318858

Simon Huang (Contact Author)

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

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