One Anomaly to Explain Them All
82 Pages Posted: 7 Sep 2019 Last revised: 5 May 2021
Date Written: August 28, 2019
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: Suggested Citation