IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v35y2011i6p1427-1435.html
   My bibliography  Save this article

Risk adjustment and momentum sources

Author

Listed:
  • Wang, Jun
  • Wu, Yangru

Abstract

We show that the conventional procedure of risk adjustment by running full-sample time-series Fama-French three-factor regressions is not appropriate for momentum portfolios because the procedure fails to allow for the systematic dynamics of momentum portfolio factor loadings. We propose a simple procedure to adjust risks associated with the Fama-French three factors for momentum portfolios. Using our proposed method, the Fama-French three factors can explain approximately 40% of momentum profits generated by individual stocks and nearly all of momentum returns from style portfolios.

Suggested Citation

  • Wang, Jun & Wu, Yangru, 2011. "Risk adjustment and momentum sources," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1427-1435, June.
    • Handle: RePEc:eee:jbfina:v:35:y:2011:i:6:p:1427-1435
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378-4266(10)00411-5
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. Wayne E. Ferson & Campbell R. Harvey, 1999. "Conditioning Variables and the Cross Section of Stock Returns," Journal of Finance, American Finance Association, vol. 54(4), pages 1325-1360, August.
    3. Guo, Hui, 2006. "Time-varying risk premia and the cross section of stock returns," Journal of Banking & Finance, Elsevier, vol. 30(7), pages 2087-2107, July.
    4. Harrison Hong & Jeremy C. Stein, 1999. "A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets," Journal of Finance, American Finance Association, vol. 54(6), pages 2143-2184, December.
    5. repec:bla:jfinan:v:59:y:2004:i:4:p:1743-1776 is not listed on IDEAS
    6. Tarun Chordia & Lakshmanan Shivakumar, 2002. "Momentum, Business Cycle, and Time‐varying Expected Returns," Journal of Finance, American Finance Association, vol. 57(2), pages 985-1019, April.
    7. Gu, Li & Huang, Dayong, 2010. "Sales order backlogs and momentum profits," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1564-1575, July.
    8. Barberis, Nicholas & Shleifer, Andrei, 2003. "Style investing," Journal of Financial Economics, Elsevier, vol. 68(2), pages 161-199, May.
    9. Grundy, Bruce D & Martin, J Spencer, 2001. "Understanding the Nature of the Risks and the," The Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 29-78.
    10. Barberis, Nicholas & Shleifer, Andrei & Vishny, Robert, 1998. "A model of investor sentiment," Journal of Financial Economics, Elsevier, vol. 49(3), pages 307-343, September.
    11. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    12. Jonathan Lewellen & Jay Shanken, 2002. "Learning, Asset‐Pricing Tests, and Market Efficiency," Journal of Finance, American Finance Association, vol. 57(3), pages 1113-1145, June.
    13. Chen, Hsiu-Lang & De Bondt, Werner, 2004. "Style momentum within the S&P-500 index," Journal of Empirical Finance, Elsevier, vol. 11(4), pages 483-507, September.
    14. Kevin Q. Wang, 2003. "Asset Pricing with Conditioning Information: A New Test," Journal of Finance, American Finance Association, vol. 58(1), pages 161-196, February.
    15. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    16. Jonathan B. Berk & Richard C. Green & Vasant Naik, 1999. "Optimal Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 54(5), pages 1553-1607, October.
    17. Lo, Andrew W & MacKinlay, A Craig, 1990. "When Are Contrarian Profits Due to Stock Market Overreaction?," The Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 175-205.
    18. Dong-Hyun Ahn & Jennifer Conrad & Robert F. Dittmar, 2003. "Risk Adjustment and Trading Strategies," The Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 459-485.
    19. Timothy C. Johnson, 2002. "Rational Momentum Effects," Journal of Finance, American Finance Association, vol. 57(2), pages 585-608, April.
    20. John Y. Campbell & Tuomo Vuolteenaho, 2004. "Bad Beta, Good Beta," American Economic Review, American Economic Association, vol. 94(5), pages 1249-1275, December.
    21. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
    22. Wu, Xueping, 2002. "A conditional multifactor analysis of return momentum," Journal of Banking & Finance, Elsevier, vol. 26(8), pages 1675-1696, August.
    23. Balvers, Ronald J. & Wu, Yangru, 2006. "Momentum and mean reversion across national equity markets," Journal of Empirical Finance, Elsevier, vol. 13(1), pages 24-48, January.
    24. Jonathan Lewellen, 2002. "Momentum and Autocorrelation in Stock Returns," The Review of Financial Studies, Society for Financial Studies, vol. 15(2), pages 533-564, March.
    25. Fama, Eugene F & French, Kenneth R, 1996. "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    26. Tobias J. Moskowitz & Mark Grinblatt, 1999. "Do Industries Explain Momentum?," Journal of Finance, American Finance Association, vol. 54(4), pages 1249-1290, August.
    27. Chordia, Tarun & Shivakumar, Lakshmanan, 2006. "Earnings and price momentum," Journal of Financial Economics, Elsevier, vol. 80(3), pages 627-656, June.
    28. Narasimhan Jegadeesh & Sheridan Titman, 2001. "Profitability of Momentum Strategies: An Evaluation of Alternative Explanations," Journal of Finance, American Finance Association, vol. 56(2), pages 699-720, April.
    29. repec:bla:jfinan:v:53:y:1998:i:1:p:267-284 is not listed on IDEAS
    30. Grinblatt, Mark & Han, Bing, 2005. "Prospect theory, mental accounting, and momentum," Journal of Financial Economics, Elsevier, vol. 78(2), pages 311-339, November.
    31. Conrad, Jennifer & Kaul, Gautam, 1998. "An Anatomy of Trading Strategies," The Review of Financial Studies, Society for Financial Studies, vol. 11(3), pages 489-519.
    32. Doron Avramov & Tarun Chordia & Gergana Jostova & Alexander Philipov, 2007. "Momentum and Credit Rating," Journal of Finance, American Finance Association, vol. 62(5), pages 2503-2520, October.
    33. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, June.
    34. Sagi, Jacob S. & Seasholes, Mark S., 2007. "Firm-specific attributes and the cross-section of momentum," Journal of Financial Economics, Elsevier, vol. 84(2), pages 389-434, May.
    35. Harvey, Campbell R., 1989. "Time-varying conditional covariances in tests of asset pricing models," Journal of Financial Economics, Elsevier, vol. 24(2), pages 289-317.
    36. Chan, Louis K C & Jegadeesh, Narasimhan & Lakonishok, Josef, 1996. "Momentum Strategies," Journal of Finance, American Finance Association, vol. 51(5), pages 1681-1713, December.
    37. John M. Griffin & Xiuqing Ji & J. Spencer Martin, 2003. "Momentum Investing and Business Cycle Risk: Evidence from Pole to Pole," Journal of Finance, American Finance Association, vol. 58(6), pages 2515-2547, December.
    38. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. "Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
    39. Fama, Eugene F & French, Kenneth R, 1995. "Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-155, March.
    40. Laura Xiaolei Liu & Lu Zhang, 2008. "Momentum Profits, Factor Pricing, and Macroeconomic Risk," The Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2417-2448, November.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Cheema, Muhammad A. & Scrimgeour, Frank, 2019. "Oil prices and stock market anomalies," Energy Economics, Elsevier, vol. 83(C), pages 578-587.
    2. Saji Thazhungal Govindan Nair, 2021. "On extreme value theory in the presence of technical trend: pre and post Covid-19 analysis of cryptocurrency markets," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 14(4), pages 533-561, December.
    3. Garcia-Feijoo, Luis & Jensen, Gerald R. & Jensen, Tyler K., 2018. "Momentum and funding conditions," Journal of Banking & Finance, Elsevier, vol. 88(C), pages 312-329.
    4. Yao, Yaqiong, 2012. "Momentum, contrarian, and the January seasonality," Journal of Banking & Finance, Elsevier, vol. 36(10), pages 2757-2769.
    5. Morelli, David, 2014. "Momentum profits and conditional time-varying systematic risk," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 29(C), pages 242-255.
    6. Martin H. Schmidt, 2017. "Trading strategies based on past returns: evidence from Germany," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 31(2), pages 201-256, May.
    7. Chou, Pin-Huang & Ho, Po-Hsin & Ko, Kuan-Cheng, 2012. "Do industries matter in explaining stock returns and asset-pricing anomalies?," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 355-370.
    8. Theissen, Erik & Yilanci, Can, 2020. "Momentum? What Momentum?," CFR Working Papers 20-09, University of Cologne, Centre for Financial Research (CFR).
    9. Chen Su, 2021. "A comprehensive investigation into style momentum strategies in China," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 35(1), pages 101-144, March.
    10. Bohl, Martin T. & Czaja, Marc-Gregor & Kaufmann, Philipp, 2016. "Momentum profits, market cycles, and rebounds: Evidence from Germany," The Quarterly Review of Economics and Finance, Elsevier, vol. 61(C), pages 139-159.
    11. Yeng May Tan & Fan Fah Cheng, 2019. "Industry- and liquidity-based momentum in Australian equities," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 5(1), pages 1-18, December.
    12. Jiang, Fuwei & Jin, Fujing & Tang, Guohao, 2020. "Dissecting the effectiveness of firm financial strength in predicting Chinese stock market," Finance Research Letters, Elsevier, vol. 32(C).
    13. Hong-Yi Chen & Sheng-Syan Chen & Chin-Wen Hsin & Cheng Few Lee, 2020. "Does Revenue Momentum Drive or Ride Earnings or Price Momentum?," World Scientific Book Chapters, in: Cheng Few Lee & John C Lee (ed.), HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING, chapter 94, pages 3263-3318, World Scientific Publishing Co. Pte. Ltd..
    14. Shi, Huai-Long & Zhou, Wei-Xing, 2017. "Wax and wane of the cross-sectional momentum and contrarian effects: Evidence from the Chinese stock markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 486(C), pages 397-407.
    15. Matallín-Sáez, Juan Carlos & Soler-Domínguez, Amparo & Tortosa-Ausina, Emili, 2016. "On the robustness of persistence in mutual fund performance," The North American Journal of Economics and Finance, Elsevier, vol. 36(C), pages 192-231.
    16. Mehdi Zolfaghari & Bahram Sahabi, 2021. "The impact of oil price and exchange rate on momentum strategy profits in stock market: evidence from oil-rich developing countries," Review of Managerial Science, Springer, vol. 15(7), pages 1981-2023, October.
    17. Hannah Lea Hühn & Hendrik Scholz, 2018. "Alpha Momentum and Price Momentum," IJFS, MDPI, vol. 6(2), pages 1-28, May.
    18. Ali Fayyaz Munir & Mohd Edil Abd. Sukor & Shahrin Saaid Shaharuddin, 2022. "Adaptive Market Hypothesis and Time-varying Contrarian Effect: Evidence From Emerging Stock Markets of South Asia," SAGE Open, , vol. 12(1), pages 21582440211, January.
    19. Huynh, Thanh D., 2017. "Conditional asset pricing in international equity markets," International Review of Economics & Finance, Elsevier, vol. 49(C), pages 168-189.
    20. Jungshik Hur & Vivek Singh, 2016. "Reexamining momentum profits: Underreaction or overreaction to firm-specific information?," Review of Quantitative Finance and Accounting, Springer, vol. 46(2), pages 261-289, February.
    21. Andreu, Laura & Matallín-Sáez, Juan Carlos & Sarto, José Luis, 2018. "Mutual fund performance attribution and market timing using portfolio holdings," International Review of Economics & Finance, Elsevier, vol. 57(C), pages 353-370.
    22. Hannah Lea Hühn & Hendrik Scholz, 2019. "Reversal and momentum patterns in weekly stock returns: European evidence," Review of Financial Economics, John Wiley & Sons, vol. 37(2), pages 272-296, April.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, October.
    2. Simarjeet Singh & Nidhi Walia, 2022. "Momentum investing: a systematic literature review and bibliometric analysis," Management Review Quarterly, Springer, vol. 72(1), pages 87-113, February.
    3. Mao, Mike Qinghao & Wei, K.C. John, 2014. "Price and earnings momentum: An explanation using return decomposition," Journal of Empirical Finance, Elsevier, vol. 28(C), pages 332-351.
    4. Hong Zhang, 2004. "Dynamic Beta, Time-Varying Risk Premium, and Momentum," Yale School of Management Working Papers amz2637, Yale School of Management, revised 01 Mar 2005.
    5. Hong-Yi Chen & Sheng-Syan Chen & Chin-Wen Hsin & Cheng Few Lee, 2020. "Does Revenue Momentum Drive or Ride Earnings or Price Momentum?," World Scientific Book Chapters, in: Cheng Few Lee & John C Lee (ed.), HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING, chapter 94, pages 3263-3318, World Scientific Publishing Co. Pte. Ltd..
    6. Subrahmanyam, Avanidhar, 2018. "Equity market momentum: A synthesis of the literature and suggestions for future work," Pacific-Basin Finance Journal, Elsevier, vol. 51(C), pages 291-296.
    7. Goetzmann, William N. & Huang, Simon, 2018. "Momentum in Imperial Russia," Journal of Financial Economics, Elsevier, vol. 130(3), pages 579-591.
    8. Hong Zhang, 2004. "Dynamic Beta, Time-Varying Risk Premium, and Momentum," Yale School of Management Working Papers amz2637, Yale School of Management, revised 01 Mar 2005.
    9. Chris Stivers & Licheng Sun, 2013. "Market Cycles and the Performance of Relative Strength Strategies," Financial Management, Financial Management Association International, vol. 42(2), pages 263-290, June.
    10. Hao, Ying & Chou, Robin K. & Ko, Kuan-Cheng & Yang, Nien-Tzu, 2018. "The 52-week high, momentum, and investor sentiment," International Review of Financial Analysis, Elsevier, vol. 57(C), pages 167-183.
    11. Ana-Maria Fuertes & Joëlle Miffre & Wooi-Hou Tan, 2009. "Momentum profits, nonnormality risks and the business cycle," Applied Financial Economics, Taylor & Francis Journals, vol. 19(12), pages 935-953.
    12. Wahal, Sunil & Yavuz, M. Deniz, 2013. "Style investing, comovement and return predictability," Journal of Financial Economics, Elsevier, vol. 107(1), pages 136-154.
    13. Fernando F. Ferreira & A. Christian Silva & Ju-Yi Yen, 2014. "Information ratio analysis of momentum strategies," Papers 1402.3030, arXiv.org, revised Jul 2014.
    14. Menkhoff, Lukas & Sarno, Lucio & Schmeling, Maik & Schrimpf, Andreas, 2012. "Currency momentum strategies," Journal of Financial Economics, Elsevier, vol. 106(3), pages 660-684.
    15. Wang, Kevin Q. & Xu, Jianguo, 2015. "Market volatility and momentum," Journal of Empirical Finance, Elsevier, vol. 30(C), pages 79-91.
    16. Du, Ding & Denning, Karen, 2005. "Industry momentum and common factors," Finance Research Letters, Elsevier, vol. 2(3), pages 107-124, September.
    17. Sagi, Jacob S. & Seasholes, Mark S., 2007. "Firm-specific attributes and the cross-section of momentum," Journal of Financial Economics, Elsevier, vol. 84(2), pages 389-434, May.
    18. Fernando F. Ferreira & A. Christian Silva & Ju-Yi Yen, 2019. "Detailed study of a moving average trading rule," Papers 1907.00212, arXiv.org.
    19. Yang, Yunlin & Gebka, Bartosz & Hudson, Robert, 2019. "Momentum effects in China: A review of the literature and an empirical explanation of prevailing controversies," Research in International Business and Finance, Elsevier, vol. 47(C), pages 78-101.
    20. Chen Su, 2021. "A comprehensive investigation into style momentum strategies in China," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 35(1), pages 101-144, March.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:35:y:2011:i:6:p:1427-1435. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.