Momentum Strategies: An Industry Presentation and some Academic Research

At one point, momentum strategies had a very bad reputation in academia, even though they have always been a staple of currency and commodity traders.

Certainly the weak form EMH tells us that momentum strategies can't possibly work. Nevertheless, the many of the world's currency and commodity traders spend most of their time doing little else. They consider fundamental arguments and flow-of-funds arguments, but in their heart, they are "the trend is your friend" kinds of people.

Academia has been catching up for a while. It turns out that there are plenty of contexts and plenty of times where momentum trades stand up to all of the hand wringing the ivory tower can muster.

Excess returns to momentum strategies now live in the domain of "puzzles" and "anomalies."

EMH defenders see the historical record and calmly say "There must be some reason for this weirdness, but I can't yet put my finger on it."

There is a lot to reflect upon.

If momentum strategies work, as apparently they do, why is there not enough capital applied to them so that the excess return goes away? Excess returns to momentum trades may indeed be on the way out, but for the moment momentum trades are alive and well.

Finally, if momentum players win, from whom do they win? One group would be the holders of the biggest portfolios. Market impact costs prevent them from changing their positions very quickly. Another group would be those large capital gains. They are chained to their positions by tax consequences. These are honest possibility for the possibility of excess returns to momentum strategies.

These are all puzzles.

Concrete Variation and Strategy Hunting

Conventional Beta are really the "5-year monthly data" Betas, and you can test for yourself that they have nothing to do with returns --- which is a thorn in CAPMs side. Still, there are lots of variations to try. One paper suggests that "9-year yearly" betas are positively associated with excess returns (LOL, can you spell "survivor bias" and "not enough data). The same paper says that "1-year daily betas" are negatively associated with excess return.

The authors put these together and find cheese. I am very skeptical. Still, it would be a nice project to explore some to the ideas of this paper --- except for the "9-year yearly" that idea is a non-starter, except by some strange fluke.

More Items to Consider

A Strategy Presentation to CitiGroup FX Clients

CitiCorp Presentation on FX Momentum Strategies. It's not scholarly, but it is informative of an industry view.

It is also true that lots of people have found (historically at least) that there is something to the momentum story in currencies.

Note: This presentation uses the notion of Information Ratio (IR) which is a tool for comparing managers or strategies versus a benchmark. Basically it is the excess return divided by the standard deviation of the excess return. For example, the Sharpe ratio is the IR with the benchmark being the risk free rate. Wikipedia gives a little more detail.


Three Academic Papers on Momentum (out of zillions)

Momentum Strategies by Chan, Jegadeesh, and Lakonishok (JF 1996)

Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies by Hong, Lim, and Stein (JF 2000)

Profitability of Momentum Strategies: An Evaluation of Alternative Explanations by Jegadeesh and Titman (JF 2001)


You can find more recent papers than these by searching for the papers that cite these "classics." If you find either academic papers or 'sell side' research that you think would be useful for the class, please pass your recommendations to me and I will post them for the class.

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