Finding Alphas, 2nd Edition

21Introduction to Momentum Alphas

By Zhiyu Ma Arpit Agarwal, and and Laszlo Borda

In financial markets, “momentum” refers to the empirical observation that asset prices that have been rising are likely to rise further, and vice versa. Within the framework of the efficient market hypothesis, momentum is one of the market anomalies (along with reversion, seasonality, and momentum reversal) that originate from the fact that investors' immediate reactions may be improper and will tend to adjust over time.

In a seminal 1993 paper, Jegadeesh and Titman found that the winners and losers in the past 3–12 months are likely to continue to win and lose. The same phenomenon has been extensively studied, and it has been confirmed that momentum works for most asset classes and financial markets around the world (Chan et al. 2000; Hong and Stein 1999; Hong et al. 2000; Jegadeesh and Titman 2001, 2011; Rouwenhorst 1998). The observed profitability of momentum alphas, however, has shrunk a great deal in recent years, and they suffered a large drawdown during and around the financial crisis of 2008 (Barroso and Santa-Clara 2015). Since then, many research papers have suggested modifying the rule to enhance the potential profit and reduce the potential drawdown while keeping the spirit of a momentum alpha (Antonacci 2014). This continues to be an active field of research within the academic community.

Researchers have attempted to explain through behavioral models why momentum alphas work. According ...