Abstract
AbstractWe propose an investment‐momentum strategy of buying past winners with low investment and selling past losers with high investment, which simultaneously exploits two dimensions of market inefficiencies. The new strategy generates twice the monthly returns earned by either the price momentum or investment strategy (1.44% vs. 0.75% or 0.61%). Despite the diminishing anomalies in recent decades, the investment‐momentum stays persistent. The mispricing‐based strategy performs better in periods of high investor sentiment or for stocks with high limits‐to‐arbitrage, which is consistent with our expectations. Overall, we show that one can simultaneously use multiple dimensions of market inefficiency to attain superior performance.
Highlights
Price momentum is pervasive and has been observed across periods (Chan, Jegadeesh, & Lakonishok, 1996; Jegadeesh & Titman, 1993, 2001), countries (Griffin, Ji, & Martin, 2004; Rouwenhorst, 1998), and markets (Asness, Moskowitz, & Pedersen, 2013; Menkhoff, Sarno, Schmeling, & Schrimpf, 2012)
We find that the investment momentum is more pronounced in periods of high investor sentiment or for stocks subject to high limits to arbitrage, which further confirms our multi-dimensional mispricing approach
It is not difficult to understand why the focus has long been on fundamentals, as Huang et al (2019) argue that ‘academic research and education are almost entirely fundamentals’
Summary
Price momentum is pervasive and has been observed across periods (Chan, Jegadeesh, & Lakonishok, 1996; Jegadeesh & Titman, 1993, 2001), countries (Griffin, Ji, & Martin, 2004; Rouwenhorst, 1998), and markets (Asness, Moskowitz, & Pedersen, 2013; Menkhoff, Sarno, Schmeling, & Schrimpf, 2012). 2145), it seems unnecessary for them to consider anything other than past prices.1 With respect to this question, Baker, Stein, and Wurgler (2003) and Polk and Sapienza (2009) show that stock market mispricing influences firms' investment and ‘firms that overinvest are overpriced’ If the mispricing indicated by investment is fully captured by the price momentum, the investment should have no added value to momentum traders. If this is not the case, it is likely to add incremental value to momentum traders and, an opportunity for them to arbitrage away, over and above, any underreaction left behind by the newswatchers.. Our investment-momentum (InvMom) strategy seems to be supported by the evidence from Hou et al (2020) who classify 452 documented anomalies into six broad categories
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