Time Series Momentum in the US Stock Market: Empirical Evidence and Theoretical Analysis

Abstract

There is much controversy in the academic literature on the presence of short-term trends in financial markets and the trend-following strategy's profitability. We restrict our attention to studying the time series momentum in the S&P Composite stock price index. Our contributions are both empirical and theoretical. On the empirical side, we present compelling evidence of the presence of short-term momentum. For the first time, we suppose that the returns follow a p-order autoregressive process and evaluate this process's parameters. On the theoretical side, we develop a tractable theoretical model that contributes to our fundamental understanding of the trend-following strategy's risk, return, and performance. Using our model, we also estimate the power of statistical tests on the trend-following strategy's profitability and find that these tests suffer from the low power problem.

Keywords: time series momentum, trend-following, profitability, statistical power

JEL Classification: G12, G14, G17