TY - JOUR
T1 - Understanding momentum and reversal
AU - Kelly, Bryan T.
AU - Moskowitz, Tobias J.
AU - Pruitt, Seth
N1 - Publisher Copyright:
© 2021 Elsevier B.V.
PY - 2021
Y1 - 2021
N2 - Stock momentum, long-term reversal, and other past return characteristics that predict future returns also predict future realized betas, suggesting these characteristics capture time-varying risk compensation. We formalize this argument with a conditional factor pricing model. Using instrumented principal components analysis, we estimate latent factors with time-varying factor loadings that depend on observable firm characteristics. We show that factor loadings vary significantly over time, even at short horizons over which the momentum phenomenon operates (one year), and this variation captures reliable conditional risk premia missed by other factor models commonly used in the literature. Our estimates of conditional risk exposure can explain a sizable fraction of momentum and long-term reversal returns and can be used to generate even stronger return predictions.
AB - Stock momentum, long-term reversal, and other past return characteristics that predict future returns also predict future realized betas, suggesting these characteristics capture time-varying risk compensation. We formalize this argument with a conditional factor pricing model. Using instrumented principal components analysis, we estimate latent factors with time-varying factor loadings that depend on observable firm characteristics. We show that factor loadings vary significantly over time, even at short horizons over which the momentum phenomenon operates (one year), and this variation captures reliable conditional risk premia missed by other factor models commonly used in the literature. Our estimates of conditional risk exposure can explain a sizable fraction of momentum and long-term reversal returns and can be used to generate even stronger return predictions.
KW - Conditional betas
KW - Conditional expected returns
KW - Factor model
KW - IPCA
KW - Momentum
KW - Reversal
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U2 - 10.1016/j.jfineco.2020.06.024
DO - 10.1016/j.jfineco.2020.06.024
M3 - Article
AN - SCOPUS:85103253919
SN - 0304-405X
JO - Journal of Financial Economics
JF - Journal of Financial Economics
ER -