What Can Explain Momentum? Evidence from Decomposition

Abstract

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.

Capital gains overhang and irrelevant value characteristics of Brazilian companies

“…Our result, consistent with Guo et al (2022) also suggests the existence of the momentum anomaly in the Brazilian financial market, since CGO, through the disposition effect, would be able to generate momentum.…”

“…Therefore, for a winning (losing) stock that is undervalued (overvalued), its price will gradually rise (fall) to the correct equilibrium level (Li, 2016). Guo et al (2022) show that prospect theory and mental accounting are among the most important drivers to explain the momentum anomaly and use capital gains overhang as a proxy for capital gains and losses to capture the effect of PT/MA. Also, Chelikani et al (2021) investigating how past stock returns affect lottery demand for the US financial market provide evidence that capital gains overhang has a positive and significant relationship with expected returns.…”