Salience theory and enhancing momentum profits

Abstract

Salience theory predicts that stocks with salient upsides are overvalued and earn lower subsequent returns, whereas those with salient downsides are undervalued and generate higher future returns. This study investigates an enhanced momentum strategy excluding stocks with extremely salient payoffs which attenuate the profitability of the momentum strategy. We find that this approach generates a significantly higher return and Sharpe ratio than the traditional momentum strategy. We further find that the performance improvement is more prominent for loser portfolios than for winner portfolios.