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The Momentum Gap and Return Predictability

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  • Simon Huang

Abstract

The formation period return difference between past winners and losers, which I call the momentum gap, negatively predicts momentum profits. I document this for the U.S. stock market and find consistent results across 21 major international markets. A one-standard-deviation increase in the momentum gap predicts a 1.25 decrease in the monthly momentum return after controlling for existing predictors. This predictability extends up to 5 years for static momentum portfolios, consistent with time-varying investor biases. Following the simple real-time strategy of investing in momentum only when the momentum gap is below the 80th percentile delivers a Sharpe ratio of 0.78.

Suggested Citation

  • Simon Huang, 2022. "The Momentum Gap and Return Predictability," The Review of Financial Studies, Society for Financial Studies, vol. 35(7), pages 3303-3336.
    • Handle: RePEc:oup:rfinst:v:35:y:2022:i:7:p:3303-3336.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhab093
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    Cited by:

    1. Chen, Hong-Yi & Hsieh, Chia-Hsun & Lee, Cheng-Few, 2023. "Revisiting the momentum effect in Taiwan: The role of persistency," Pacific-Basin Finance Journal, Elsevier, vol. 78(C).
    2. Yu, Fanchao, 2023. "Macroeconomic information, global economic policy uncertainty and gold futures return predictability," Finance Research Letters, Elsevier, vol. 55(PA).

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G40 - Financial Economics - - Behavioral Finance - - - General

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