What Can Explain Momentum? Evidence From Decomposition
66 Pages Posted: 19 Feb 2021 Last revised: 21 May 2021
Date Written: December 6, 2020
This study comprehensively evaluates and ranks a large number of competing explanations for the momentum anomaly. As a benchmark for evaluation, firm fundamentals are found to be the most promising among well-known explanations of momentum, followed by prospect theory and mental accounting, and anchoring effect. Collectively, all explanations capture 31% of momentum, while 69% of momentum remains unexplained. This study thoroughly examines what fractions of the momentum anomaly emerge from the interaction effects between past returns and various firms’ characteristics. It is further found that strategies based on firm characteristics and residual momentum can significantly alleviate the severity of momentum crashes. Finally, robustness analysis is provided for choosing different formation and holding periods, excluding January observations, and analyze at the level of portfolio rather than individual stock.
Keywords: Momentum, Momentum Candidate Variables, Momentum Decomposition, Momentum Crashes
JEL Classification: G12, G14
Suggested Citation: Suggested Citation