One Anomaly to Explain Them All

82 Pages Posted: 7 Sep 2019 Last revised: 5 May 2021

See all articles by Jack Y Favilukis

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance

Terry Zhang

Australian National University (ANU)

Date Written: August 28, 2019

Abstract

We uncover a link between overvaluation and momentum profits: a momentum strategy concentrated only within overvalued (low alpha) stocks earns twice the profit of a standard momentum strategy. First, we find stocks within which implementing a momentum strategy of buying winners and selling losers is especially profitable -- we refer to these as high Momentum Trading Opportunities (MTO). Second, we show that high MTO stocks tend to have low unconditional alphas, and are more likely to belong to portfolios in the short legs of most anomalies, such as growth, high IVOL, and high investment. Third, we build on the intuition of Hong and Stein (1999), but allow for assets with and without MTO, to explain the positive relationship between overvaluation and MTO: price pressure on MTO assets from momentum traders pushes their expected return down, thereby creating anomalies.

Keywords: Momentum, Anomalies

JEL Classification: G11, G12, G14

Suggested Citation

Favilukis, Jack Y and Zhang, Terry, One Anomaly to Explain Them All (August 28, 2019). Available at SSRN: https://ssrn.com/abstract=3444342 or http://dx.doi.org/10.2139/ssrn.3444342

Jack Y Favilukis (Contact Author)

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Terry Zhang

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

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