The Information in Book-to-Market Profits for Momentum

Abstract

In this paper I examine the relation between profits from book-to-market strategies and momentum strategies. Specifically, I test two time-series hypotheses which are not mutually exclusive, but do have opposite predictions for subsequent momentum profits. First, if periods of large book-to-market profits are indicative of a large dispersion in expected returns, then subsequent momentum profits are likely to be relatively high. Second, if shifts in book-to-market profits (a period of growth dominating value shifting to a period of value dominating growth, or vice versa) are associated with changes in the market state, then subsequent momentum profits are likely to be relatively low. My results provide no support for the first hypothesis. However, I do find support for the second hypothesis. Specifically, momentum profits are negatively and reliably related to changes in book-to-market profits prior to implementing the momentum strategy. The results are consistent with the propositions that: (1) changes in the state of the market across the ranking and holding periods are associated with lower subsequent momentum profits, and (2) price adjustments to changes in expected returns are important for understanding momentum profits.