Sunday, March 5, 2023

Factors have momentum that can be exploited beyond the momentum factor


There is momentum in individual stocks which is related to the momentum in factor returns. Factors show positive autocorrelation so that factors that had positive returns last year will also have positive reruns this year.  If the strong underlying factors that describe a stock are showing momentum, the stock will show momentum. Follow the factors and you will understand the drivers of stock momentum.  This is the result found in the work "Factor Momentum and the Momentum Factor". Factor momentum is related to the persistence of sentiment that can carry over the factor returns.  For example, the persistence of sentiment concerning small cap or value returns will then create a momentum effect for stocks with these other factor characteristics. 

The overall conclusion is that momentum is not a distinct factor. It is an aggregation of the momentum seen in other factors. This idea has strong implication for how you think about the time series behavior of stocks and the factor risks. It suggests that following factor risks and their behavior through time will provide insights on the stocks that will likely show momentum. 

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