Understanding momentum and reversal

Bryan T. Kelly, Tobias J. Moskowitz, Seth Pruitt

Research output: Contribution to journalArticlepeer-review

Abstract

Stock momentum, long-term reversal, and other past return characteristics that predict future returns also predict future realized betas, suggesting these characteristics capture time-varying risk compensation. We formalize this argument with a conditional factor pricing model. Using instrumented principal components analysis, we estimate latent factors with time-varying factor loadings that depend on observable firm characteristics. We show that factor loadings vary significantly over time, even at short horizons over which the momentum phenomenon operates (one year), and this variation captures reliable conditional risk premia missed by other factor models commonly used in the literature. Our estimates of conditional risk exposure can explain a sizable fraction of momentum and long-term reversal returns and can be used to generate even stronger return predictions.

Original languageEnglish (US)
JournalJournal of Financial Economics
DOIs
StateAccepted/In press - 2021
Externally publishedYes

Keywords

  • Conditional betas
  • Conditional expected returns
  • Factor model
  • IPCA
  • Momentum
  • Reversal

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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