The Momentum Effect in Latin American Emerging Markets

Abstract

We find that momentum strategies yield profits in Latin American emerging markets. Both stock type and country play a major role in explaining the momentum effect in these markets, but stock type is much more important. For risk-averse investors, winner portfolios stochastically dominate loser portfolios in these markets, implying that there are no asset-pricing models consistent with risk-averse investors that can rationalize the momentum effect. The results obtained via the bootstrap procedure without replacement also uphold this conclusion.The momentum effect can be described basically as short-to medium-term persistence in stock returns; that is, winners and losers maintain the same return patterns for periods of approximately three to twelve months (Jegadeesh and Titman 1993). Though the bulk of the empirical evidence has been found for the U.S. market, 1 studies document the effect in other stock markets as well. Rouwenhorst (1998) finds evidence of the momentum effect in twelve European countries, Hon and Tonks (the country level. Fong et al. (2005) and Shen et al. (2005) present evidence of the momentum effect using international market indexes for both developed and emerging markets. Among a number of articles that analyze the momentum effect in emerging markets, Rouwenhorst (1999), Van der Hart et al. (2003), andGriffin et al. (2003) are all worth special mention. The overriding conclusion from all of the research is that momentum exists in emerging markets, but it is less intense than it is in more developed countries. However, the data used in the above-mentioned studies are not very recent; the last three studies cover periods from the 1980s to 1997, 1999, and 2000, respectively. Despite a number of different theories, the momentum effect, unlike other market anomalies, has never been explained to the unanimous satisfaction of researchers. Some authors suggest that the momentum effect is due to cross-sectional variations in stocks (see Conrad and Kaul 1998). Others claim that medium-term continuations are related to macroeconomic risk factors (Avramov and Chordia 2006; Chordia and Shivakumar 2002), and some attempt to relate the momentum effect to downside risk (Ang et al. 2001). Studies also link the effect to seasonal factors (Grinblatt and Moskowitz 2004; Hvidkjaer 2006) or to the importance of the transaction costs incurred in implementing momentum strategies (Lesmond et al. 2004) instead of implementing strategies of this type (Lesmond et al. 2004).Against such a background, attention must also be paid to explanations emerging from the study of investor behavior. Some authors who subscribe to the theory widely known as behavioral finance suggest that, by responding "irrationally" to various types of news, investors may provoke an underreaction, which would produce the momentum effect. Others have linked it to long-run overreaction (De Bondt and Thaler 1985), the theory being that the correction of delayed overreaction explains the long-term reversal, an overall perspective that captures both e...

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