Abstract
This paper examines the role of illiquidity and duration factor in understanding the momentum profit in the Korean stock market. We find that the foreigner/institutional illiquidity factor explains the momentum effect. In addition, this paper finds that duration factor defined as the difference in returns of short-duration and long-duration stocks captures well the momentum profits. That is, a two-factor model with the market and duration factor performs much better than competing asset pricing models in explaining the momentum effect. Finally, when controlling for the duration factor, the explanatory power of the foreign/institutional illiquidity factor on the momentum profits disappears. In sum, our empirical finding indicates that the duration factor is the most important ingredient in understanding the momentum effect in the Korean stock market.
Highlights
The momentum effect, relatively high-performance stocks in the past 6–12 months continue to outperform in the 6–12 months, is one of the most puzzling phenomena in finance
We examine the explanatory power of the duration factor for the momentum strategy returns
We attempt to understand the driving force behind the momentum effect in the Korean stock market, and we examine the ability of the illiquidity factor and duration factor to explain the momentum strategy returns
Summary
The momentum effect, relatively high-performance stocks in the past 6–12 months continue to outperform in the 6–12 months, is one of the most puzzling phenomena in finance. We use the illiquidity factor because prior studies report that the performance of the momentum strategy is positively related to market liquidity (Avramov et al, 2016; Kim and Lee, 2018). In the Korean stock market, the duration factor defined as the difference between the realized return of short-term and long-term duration stocks earns a significantly positive premium which is not explained by the existing asset pricing models. While earlier works studying pre-Asian financial crisis period report that momentum effect does not exist, recent studies using post-Asian financial crisis period data or relatively long-term data find the momentum effect in the Korean stock market. Jang (2017) reports that the performance of the intermediate-term momentum strategy, which is formed using the past 12 to 7 month returns, outperforms the performance of the momentum strategy using the returns in the past six months, consistent with the findings of Novy-Marx (2012) in the US stock market
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