Understanding Momentum and Reversal

1 Pages Posted: 4 Nov 2018 Last revised: 27 Nov 2018

See all articles by Bryan T. Kelly

Bryan T. Kelly

Yale SOM; AQR Capital Management, LLC; National Bureau of Economic Research (NBER)

Tobias J. Moskowitz

Yale University, Yale SOM; AQR Capital; National Bureau of Economic Research (NBER)

Seth Pruitt

Arizona State University (ASU) - Finance Department

Date Written: October 7, 2018

Abstract

We show that the momentum and long-term reversal effects are explained by a conditional factor pricing model. We use instrumented principal components analysis to construct an improved conditional model in which dynamic loadings are functions of observable firm characteristics. Model-based expected returns, which are solely determined by exposures to systematic risk factors, provide much stronger predictive power for future realized returns than momentum or long-term reversal. We show that these return trend variables "work" because they are imperfect proxies for time-varying beta compensation, and that properly measured conditional betas render the effects of momentum and long-term reversal small and insignificant. In contrast, the short-term reversal phenomenon is distinct from the conditional pricing model, consistent with a pure liquidity effect.

Keywords: momentum, factor model, conditional betas, conditional expected returns, IPCA

JEL Classification: G12

Suggested Citation

Kelly, Bryan T. and Moskowitz, Tobias J. and Pruitt, Seth, Understanding Momentum and Reversal (October 7, 2018). Available at SSRN: https://ssrn.com/abstract=3269897 or http://dx.doi.org/10.2139/ssrn.3269897

Bryan T. Kelly

Yale SOM ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Tobias J. Moskowitz

Yale University, Yale SOM ( email )

New Haven, CT 06520
United States

HOME PAGE: http://som.yale.edu/tobias-j-moskowitz

AQR Capital ( email )

Greenwich, CT
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Seth Pruitt (Contact Author)

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

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