Can a Risk-Based Factor Generate Momentum?

Abstract

We study whether a risk-based pricing source can generate momentum profits. We show both analytically and empirically that the Fama-French factor-adjusted return, or alphas, contains a missing risk-based component. A momentum strategy based on a proxy for this missing-factor component generates sizable profits. Returns of a factor-mimicking portfolio constructed on the basis of this proxy have robust and significant power in pricing cross-sectional variations of stock returns and forecasting future macroeconomic activities. This portfolio's stocks represent about 50% of winner/loser stocks of the momentum strategies based on either raw returns or alphas.

Keywords: Momentum, stock compositions, factor-related component, firm-specific component

JEL Classification: G12, G14