What Can Explain Momentum? Evidence from Decomposition

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 anch...

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Bibliographic Details
Published in:Management science 2022-08, Vol.68 (8), p.6184-6218
Main Authors: Guo, Jiaqi, Li, Peng, Li, Youwei
Format: Article
Language:English
Subjects:
Accounting
Financial performance
momentum
momentum candidate variables
momentum crashes
momentum decomposition
Prospect theory
Rates of return
Robustness
Stocks
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Summary: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, whereas 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 firm 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. This paper was accepted by David Simchi-Levi, finance.
ISSN:0025-1909
1526-5501
DOI:10.1287/mnsc.2021.4135