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Separating momentum from reversal in international stock markets

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Abstract

Taking into account expected return characteristics like firm size and book-to-market in the selection of winners and losers helps to ex ante separate stocks with momentum from those that exhibit reversal in international equity markets. A strategy that buys small value winners and sells large growth losers generates significantly larger momentum profits than a standard momentum strategy, is robust to common return controls, and does not suffer from return reversals for holding periods up to 3 years. The superior performance of the strategy is attributable to a rather systematic exploitation of cross-sectional mispricing among momentum stocks.

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Notes

  1. See Jegadeesh and Titman (2011) for an extended review of the literature.

  2. We do not include selling, general, and administrative expenses, as this item is not broadly available among international firms. The return predictability of operating profitability is, however, not affected by this adjustment.

  3. In line with Hirshleifer and Jiang (2010), we do not include the change in current debt, as it does not reflect market timing.

  4. For each variable, we use the full SZ, BM, and MOM distribution across all sample firms, so that the stock selection procedure corresponds to independent sorts on the three variables, as in Conrad and Yavuz (2017).

  5. These magnitudes are similar to the average turnover of value-weighted US momentum strategies (34.5%) that do not rebalance stocks to initial weights (Novy-Marx and Velikov 2016).

  6. Jegadeesh and Titman (1993) find that even when equal-weighted portfolios are used for momentum strategies, the average turnover is usually less than 100%. They report an average value of 84.8% on their strategy.

  7. The most important determinant of trading costs is the price impact, as bid-ask spreads and trading commissions do not scale with trading size.

  8. To be consistent with the intended size segmentation, the MAX and MIN strategies use tercile classifications based on the SZ, BM, and MOM distributions among the bottom or top 50% of firms and not across all sample firms.

  9. In light of this finding, we also have tested whether Japanese firms are influential in our inference that the MAX strategy is superior to the MIN strategy in international equity markets. For instance, the weighting of Japanese firms in the international MAX and MIN strategies could be responsible for the observed return difference. First, the average share of Japanese firms in the long-leg portfolios is with values of 25.99% (MAX) and 25.09% (MIN) very similar across the two strategies. Only the short-leg portfolios show, on average, a greater exposure to Japanese firms for the MAX strategy of 37.98% in comparison with 25.16% for the MIN strategy. Second, replicating the performance analysis for the MAX and MIN strategies in an international sample that excludes Japan (EAFE ex Japan) in analogy to Table 2 yields an average MAX momentum premium of 10.23% per year (t statistic of 4.45) and an average MIN momentum premium of 2.24% per year (t statistic of 1.32). Thus, the lack of momentum profits among Japanese firms cannot account for the inference that the MAX strategy is superior to the MIN strategy.

  10. The sentiment index is available at Jeffrey Wurgler’s website: http://pages.stern.nyu.edu/~jwurgler/. The index time series runs until September 2015.

  11. The noise index is available at Jun Pan’s website: http://www.mit.edu/~junpan/. The index time series runs until December 2016. The data are provided on a daily basis. We employ the index’s daily end-of-month values for our analysis.

  12. An appropriate US corporate bond index is available in Datastream from April 2002 onward.

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Authors and Affiliations

  1. Center of Finance, University of Regensburg, Universitätsstraße 31, 93053, Regensburg, Germany

    Christian Walkshäusl, Florian Weißofner & Ulrich Wessels

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  1. Christian Walkshäusl
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  2. Florian Weißofner
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  3. Ulrich Wessels
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Correspondence to Christian Walkshäusl.

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Walkshäusl, C., Weißofner, F. & Wessels, U. Separating momentum from reversal in international stock markets. J Asset Manag 20, 111–123 (2019). https://doi.org/10.1057/s41260-019-00109-5

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