Dear all,
The findings in this paper are very useful.
I use short term momentum to trade (except on individual stocks due to the short term 1 month reversal effect).
Regards
James
Highlights
- We examine more than two centuries of returns on five major asset classes.
- We demonstrate a striking short-term momentum pattern.
- The most recent month’s return positively predicts future performance.
- The effect is not explained by established return predictors—including the standard momentum.
- The strategy payoffs display partial commonality across different asset classes.
Abstract
Is there a short-term reversal effect outside the universe of individual stocks? To answer this, we investigate a comprehensive dataset of more than two centuries of returns on five major asset classes: equity indices, government bonds, treasury bills, commodities, and currencies. Contrary to stock-level evidence, we find a striking short-term momentum pattern: the most recent month’s return positively predicts future performance. The effect is not explained by established return predictors—including the standard momentum—and is robust to many considerations. The short-term momentum is strongest among assets of high idiosyncratic volatility and in periods of elevated return dispersion. Also, the strategy payoffs display partial commonality across different asset classes
https://www.sciencedirect.com/science/article/pii/S1042443119300976
Wow. The obtuseness of finance academics never fails to astonish me. First, when discussing the tendency of stocks to revert to the mean over a one-month period, they ignore the law of regression to the mean, which is a statistical law, not a tendency in stock returns. (It states, As long as there is a meaningful average of values, an extreme value will be more likely to become less extreme over time than to continue to be extreme.) Second, they do not discuss the variability of the five major asset classes. If they exhibit low variability, of course their results will be the same from month to month.
Let me illustrate this with an intuitive example. Let’s say you have five funds. One grows at a steady 1% per month. Another grows at a rate that varies between 0.25% and 0.5%. Another grows at a rate that varies between -2% and +3%. A fourth grows at a rate between 1.25% and 1.85%. And a fifth grows at a rate between -0.25% and 1%.
Obviously, the first fund is always going to beat the second and fifth fund, and the fourth fund is always going to beat all the other funds except, sometimes, the third. By the authors’ own measure, this set of funds is going to exhibit very strong short-term momentum!
Now this is an extreme example, and asset classes don’t behave like the funds above. But there are some similarities. Equity indices tend to outperform the other classes; currencies tend to underperform; equities and commodities are much more variable than government bonds and treasury bills; treasury bills are a subset of government bonds; and so on. A study of five asset classes that each show a great deal of persistence in their overall behavior cannot be compared to a study of thousands of stocks that all behave wildly, like stocks normally do.
To sum up in statistical terms, the law of regression to the mean is mitigated by time-series stationarity. The word “stationarity” does not appear once in the paper.
Yuval,
So to make it short, you don’t agree with the author’s findings and short term momentum, right?
I currently use short term momentum to trade ETFs (based on equity and commodity indices) and it appears to work fine.
I won’t comment on the 1 month short term reversal for stocks but I tried not to use it on individual stocks as this particular point has been mentioned previously in a lot of investment research, not just this one.
Thanks for getting back to me. Here is something from SSRN on one month stock reversal.
Regards
James
I don’t disagree with the authors’ findings. I found them obvious.