Understanding Momentum and Reversals

38 Pages Posted: 19 Jun 2020

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: May 26, 2020

Abstract

Stock momentum, long-term reversal, and other past return characteristics that predict future returns also predict future realized betas, suggesting these characteristics capture time-varying risk compensation. We formalize this argument with a conditional factor pricing model. Using instrumented principal components analysis, we estimate latent factors with time-varying factor loadings that depend on observable firm characteristics. We show that factor loadings vary significantly over time, even at short horizons over which the momentum phenomenon operates (one year), and that this variation captures reliable conditional risk premia missed by other factor models commonly used in the literature. Our estimates of conditional risk exposure can explain a sizeable fraction of momentum and long-term reversal returns and can be used to generate even stronger return predictions.

Keywords: momentum, reversal, factor model, conditional betas, conditional ex- pected returns, IPCA

JEL Classification: G10,G11,G12,G14

Suggested Citation

Kelly, Bryan T. and Moskowitz, Tobias J. and Pruitt, Seth, Understanding Momentum and Reversals (May 26, 2020). Available at SSRN: https://ssrn.com/abstract=3610814 or http://dx.doi.org/10.2139/ssrn.3610814

Bryan T. Kelly (Contact Author)

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

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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