Co-momentum and arbitrage; another tool for improving momentum strategies

The returns for the momentum strategy can be measured through the activity of arbitrageurs who create co-movement of returns. When the co-momentum is relatively low, the momentum strategy is not crowded. When there is less crowdedness, the returns to momentum should be positive and not likely to revert. When co-movement is high, there is likely to be a higher probability of returns to mean revert and reduce overall returns. If there is no co-momentum, there is more stabilizing behavior from arbitrageurs. If there is too much arbitrage activity, that is higher co-momentum, there will be overshooting and destabilizing behavior. The behavior of momentum will be time varying which will mean that there is under and overreaction from momentum.  See "Co-momentum: Inferring Arbitrage Activity from Return Correlations"

What is notable is that this behavior with respect to the momentum strategy is not seen with the co-value behavior or the abnormal return correlation among value stocks. When there is not more co-value, there will be higher returns because arbitrageurs re pushing returns to fair value and increasing the returns from holding value stocks. Momentum does not have fundamental anchors, so more momentum trading will lead to destabilizing behavior.

So how is co-momentum measured?  The asset universe is sorted by the past returns as traditionally done with any momentum strategy. The partial correlations for the past year are then found for each momentum decile from the ranking period. The average partial correlation or co-momentum can be found for the loser and winner deciles for some rolling past period.  When the co-momentum is high there is likely to be lower momentum strategy returns.