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ABSTRACT
This paper provides a historical review of the performance of the risk-adjusted momentum strategies when buying and selling stocks according to the alpha estimates of the CAPM and Fama-French regressions. Our sample covers over 60 million US daily firm-return observations. High Sharpe ratios are obtained under our risk-adjusted strategies. It is also found that stock market crashes have no apparent impact on our momentum profits.
Keywords: Momentum Strategies; Sharpe Ratio; Fama-French Model; CAPM Model.
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1.INTRODUCTION
The momentum trading strategy has received increasing academic attention over the past two decades since the pioneering work of Jegadeesh and Titman (1993), who show that strategies of long winner stocks and short loser stocks over the past 3 to 12 months generate a monthly return of 1 percent in the US market. Similarly, Chan et al.(2000) find the existence of momentum profits in 23 international stock markets. Chong and Ip (2009) show that momentum profits exist in emerging currency markets. However, a debate still remains concerning the source of the profits and the interpretation of momentum profits. Risk-based explanations argue that momentum profits result from exposures to certain risk variables that are not priced in the traditional models of expected returns. For instance, Daniel and Titman (1999) argue that firms with high market-to-book ratios produce enhanced momentum profits. Grinblatt and Moskowitz (1999) suggest that the momentum profits can be attributed to the industry effect. Chordia and Shivakumar (2002) find evidence that macroeconomic factors perform well in capturing the variation of momentum profits. Grinblatt and Moskowitz (2003) show that growth firms have a higher momentum effect. Sagi and Seasholes (2007) identify a variety of observable firm-specific attributes that drive momentum profits. In contrast, the behavioural explanations by Barberis et al. (1998), Daniel et al. (1998) and Hong and Stein (1999) show that cognitive biases lead investors to underreact to new information, contributing to the persistent profits of the momentum trading strategy.
The empirical evidence lends support to these behavioural models as well. Fama and French (2004) demonstrate that their three-factor models cannot explain the profits of the momentum strategy. Jegadeesh and Titman (2001) show that momentum profits quickly dissipate after the investment period. Grundy and Martin (2001) and Lewellen (2002) argue that the...