Momentum Anomalies Research Articles

ENSO affects the North Atlantic Oscillation 1 year later.

We demonstrate a 1-year lagged extratropical response to the El Niño-Southern Oscillation (ENSO) in observational analyses and climate models. The response maps onto the Arctic Oscillation and is strongest in the North Atlantic, where it resembles the North Atlantic Oscillation (NAO). Unexpectedly, these 1-year lagged teleconnections are at least as strong as the better-known simultaneous winter connections. However, the 1-year lagged response is oppositein sign to the simultaneous response such that 1 year later, El Niño is followed by a positive NAO, whereas La Niña is followed by a negative NAO. The lagged response may also interfere with simultaneous ENSO teleconnections. We show here that these effects are unlikely to be caused by residual aliasing of ENSO cycles; rather, slowly migrating atmospheric angular momentum anomalies explain both the sign and the timing of the extratropical response. Our results have implications for understanding ENSO teleconnections, explaining observed extratropical climate variability and interpreting seasonal to interannual climate predictions.

The Fortune and crash of common risk factors in Chinese commodity markets

This paper investigates the performance of nine commonly discussed market anomalies in the Chinese commodity market. By studying a data sample from 2005 to 2020, we find the common risk factors associated with term structure and momentum anomalies effectively explain the cross-sectional excess returns and generate profitable sorting portfolios. Meanwhile, we empirically demonstrate that the term structure and momentum risk factors significantly crash during periods of high market stress, although they bring overall good outperformance in out-of-sample. We attribute these crashes to high time-varying volatility. Inspired by the augmented momentum crash strategy of Daniel and Moskowitz (2016), we construct augmented term structure and momentum risk factors to improve their performances in the Chinese commodity futures market. The out-of-sample Sharpe ratios of the term structure and momentum risk factors increase from 0.75 to 1.08 and from 0.66 to 0.77, respectively. In particular, both risk factors exhibit over 100% increments in out-of-sample Sharpe ratios during bear markets.

Do oil price shocks have any implications for stock return momentum?

The study examines the implications of structural oil price shocks on one of the most widely observed and pervasive momentum anomalies. We use a structural vector autoregression (SVAR) model to find the time-varying responses of momentum payoffs of India, Japan, the UK, and the US to different structural oil shocks—oil supply global aggregate demand shock, speculative shock, and other oil demand shocks. Structural oil shocks, particularly oil demand and speculative shocks, have important implications as conditioning information in predicting stock return momentum behavior according to the conditional asset pricing model. Overall, the results indicate that structural oil shocks have a significant impact on small cap and loser stock portfolios. Our findings have crucial implications to develop effective momentum investment strategies that consider structural oil shocks as conditioning information.

Stock Selection Modeling and Portfolio Selection in Emerging Markets

This article addresses stock selection modeling and portfolio selection and implementation in EMs. The authors view EM investing as a special case of global investing, demonstrating how stock-selection models in EMs with price momentum and forecast earnings acceleration factors can enhance returns. The authors construct index-enhanced portfolios for EMs that offer superior return-to-risk ratios relative to domestic portfolios. On the basis of back test and in real-time performance, the authors show how an EM portfolio using forecast earnings and price momentum anomalies can be developed, estimated, and implemented to generate statistically significant excess returns.

Do short‐term institutions exploit stock return anomalies?

AbstractThe literature documentsthat institutional investors in aggregate trade in the “wrong” direction of stock return anomalies. This paper explains the puzzle by isolating active institutions with a shorter‐term investment horizon (“short‐term institutions”). Based on 10 well‐known stock return anomalies, we find that these short‐term institutions indeed exploit anomalies. The results established in the literature are mostly driven by institutions with a longer‐term investment horizon, who are likely more interested in long‐run financial performance. In addition, given that institutional investors are momentum traders, we examine separately how institutional investors trade on momentum and contrarian anomalies. We show that institutions generally trade in the right direction on momentum anomalies but wrong direction on contrarian anomalies. However, over relatively short trading windows, short‐term institutions trade in the right direction of both momentum and contrarian anomalies. Furthermore, we show evidence that when short‐term institutions exploit anomalies, their trades generate significantly positive abnormal returns. Our results also imply that trading by short‐term institutions appears to be subject to liquidity provision by long‐term institutions.

Optimal characteristic portfolios

Characteristic-sorted portfolios are the workhorses of modern empirical finance, deployed widely to evaluate anomalies and construct asset pricing models. We propose a new method for their estimation that is simple to compute, makes no ex-ante assumption on the nature of the relationship between the characteristic and returns, and does not require ad hoc selections of percentile breakpoints or portfolio weighting schemes. Characteristic portfolio weights are implied directly from data, through maximizing a Mean–Variance objective function with mean and variance estimated non-parametrically from the cross-section of assets. To illustrate the method, we evaluate the size, value and momentum anomalies and find overwhelming empirical evidence of the outperformance of our methodology compared to standard methods for constructing characteristic-sorted portfolios.

INEFFICIENT MARKETS, ANOMALIES, AND INVESTOR BEHAVIOR: A LITERATURE REVIEW

This study aims to observe and analyze the accounting literature which examines the phenomena that occur in inefficient markets. This article analyzes the effect of anomalies on investor behavior and stock returns. This study begins by identifying the effects of anomalies: 1) seasonal anomalies, 2) momentum anomalies. This article identifies investor behavior; 1) overreaction/ under reaction, 2) loss aversion, and 3) overconfidence. This study primarily evaluates how anomalous effects affect investor behavior towards stock returns. Within each category, this article analyzes the findings of previous research. Evidence from inefficient market research tends to help investors to reduce excessive behavior towards the effects of anomalies and help make investment decisions. This study examines opportunities for future research and research implications in capital markets.

Semiparametric Portfolio Policies

We present a semiparametric portfolio optimization method in which portfolio weights are parameterized as a non-linear function of firm characteristics. This approach generalizes the linear parametric portfolio policy of Brandt et al. (2009) and can be applied to high-dimensional problems at a relatively low computational cost. An empirical implementation exploiting the size, value, and momentum anomalies in the universe of CRSP stocks reveals that non-linearities as well as interaction effects are both important and complementary for the portfolio construction problem. Moreover, an out-of-sample evaluation indicates that the semiparametric strategies perform well in terms of returns, risk, and risk-adjusted returns both in the absence and in the presence of transaction costs. Our evidence suggests that allowing for a more flexible relation between portfolio weights and firm characteristics can provide a more accurate description of the empirical patterns seen in data.

Characteristics-Driven Returns in Equilibrium

We reverse-engineer the equilibrium construction process of asset prices in order to obtain returns which depend on firm characteristics, possibly in a linear fashion. One key requirement is that agents must have demands that rely separately on firm characteristics and on the log-price of assets. Market clearing via exogenous (non-factor driven) supply, combined with linear demands in characteristics, yields the sought form. The coefficients in the resulting linear expressions are scaled net aggregate demands for characteristics, as well as their variations, and both can be jointly estimated via panel regressions. Conditions underpinning asset pricing anomalies are derived and underline the theoretical importance of the links between characteristics. Empirically, when the number of characteristics is small, the value and momentum anomalies are mostly driven by firm-specific fixed-effects, i.e., latent demands, which highlights the shortcomings of low-dimensional models.

The Race to Exploit Anomalies and the Cost of Slow Trading

Studying 71 anomalies, we show how the discovery of anomaly reshapes out-of-sample returns, thereby creating a contrarian effect to the general decay in returns. As a result, the average contribution of the first-day return to the portfolio value increases from 3% before the anomaly is discovered to 12% afterward and 30% in case of momentum anomalies. The effect exists in long-side and short-side portfolios and in the bought and sold stocks of both portfolios. The long-lasting effect indicates that arbitrage capital plays a key role in retaining market efficiency in the long run, implying a persistent mispricing component in anomalies.

Price momentum anomalies from three sigma corporate events – a financial event study across 16 markets

Price momentum anomalies from three sigma corporate events – a financial event study across 16 markets

Cross-sectional Examination of the Corporate Bond Market Performance - The Rise of the Momentum and Contrarian Unidentified Factor Mimicking Corporate Bond Portfolios!

We examine momentum and reversal anomalies in corporate bond returns at the firm-level employing a novel dataset, SoKat Credit, comprising bonds of 323 of the largest and liquid companies over the period from 2002 to 2020. Our study documents significant short-term reversal in the cross-sectional of corporate bond returns concentrated at the one week interval with annualized returns on the zero investment long-short portfolio of 9.9%. We also document company-level momentum spillover effect into corporate bond returns when sorting on past equity returns, that is, our “bond-stock” strategy, which delivers annualized return of 5.0% is statistically significant and robust baring the usual suspects of caveats.

Role of Equatorial Cold Tongue in Central Pacific Double-ITCZ Bias in the NCAR CESM1.2

AbstractWarm SST bias underlying the spurious southern ITCZ has long been recognized as one of the main causes for double-ITCZ bias in coupled GCMs in the central Pacific. This study demonstrates that the NCAR CESM1.2 can still simulate significant double-ITCZ bias even with cold SST bias in the southern ITCZ region, indicating that warm SST bias is not a necessary condition for double-ITCZ bias in the central Pacific. Further analyses suggest that the equatorial cold tongue (ECT) biases play important roles in the formation of double-ITCZ bias in the central Pacific. The severe cold SST biases in the ECT region in the central Pacific may enhance the SST gradient between the ECT and southern ITCZ region, strengthening the lower-troposphere dynamical convergence and hence convection in the southern ITCZ region. The formation mechanism of excessive ECT bias is further investigated. It is shown that the cold SST biases in the ECT region can be largely attributed to the anomalous cooling tendency produced by the upper-ocean zonal advection due to overly strong zonal currents. In the ECT region, the westward ocean surface zonal current is driven by the equatorial easterly surface winds. It is shown that convection bias simulated by the atmospheric model in the equatorial Amazon region may lead to easterly wind bias in the downwind side (west) of convection region. The mean Walker circulation transports these easterly wind momentum anomalies downward and westward to the surface, resulting in the overly strong surface easterly wind in the central equatorial Pacific.

How Do Risk and Mispricing Contribute to Anomalies?

This study quantifies the contributions of risk and mispricing to a comprehensive set of anomalies identified in the literature. Overall, risk and mispricing contribute equally to these anomalies; however, there is a wide variation across different categories. Mispricing is solely responsible for momentum anomalies, whereas risk is solely responsible for anomalies associated with accounting-to-market ratios. Profitability and investment anomalies are due to both risk and mispricing, while other anomalies based on information from financial statements and the stock market are mainly due to mispricing. The study highlights the importance of considering risk and mispricing together in asset-pricing research, especially when the two causes are likely to have opposite effects, as in the case of anomalies relating to financial distress and constraints.

Recession Prediction Markets and Macroeconomic Risk in Asset Prices

This paper analyzes recession prediction markets from Intrade and PredictIt where individuals bet on the binary outcome of a recession occurring by a certain date. Using a time series of such historical recession prediction market data to measure macroeconomic risk in a variety of asset classes, we find a 1% increase in ex-ante recession prediction market probability is associated with a -0.29% decline in U.S. equity markets and a -0.77 basis point decrease in the 10-Year U.S. Treasury yield. Recession prediction markets also explain a significant amount of the variation in credit spreads, the U.S. Treasury yield curve, and U.S. dollar foreign exchange rates but cannot explain the value and momentum anomalies in equity markets as well as the U.S. treasury term premium.

Optimal Characteristic Portfolios

Characteristic-sorted portfolios are the workhorses of modern empirical finance, deployed widely to evaluate anomalies and construct asset pricing models. We propose a new method for their estimation that is simple to compute; makes no ex-ante assumption on the nature of the relationship between the characteristic and returns; and does not require ad hoc selections of percentile breakpoints or portfolio weighting schemes. Characteristic portfolio weights are implied directly from data, through maximizing the expected value of a mean-variance utility function estimated non-parametrically over the cross section of the assets. To illustrate the method we use it to evaluate the size, value and momentum anomalies.

On the Interrelation between Spring Bihemispheric Circulations at Middle and High Latitudes

Bihemispheric atmospheric interaction and teleconnection allow us to deepen our understanding of large-scale climate and weather variability. This study uses 1979−2017 spring NCEP reanalysis to show that there is interrelation between bihemispheric circulations at the extratropics. This is regarded as a significant negative correlation between the Antarctic and the Arctic regional surface air pressure anomalies, which is induced by interhemispheric oscillation (IHO) of the atmospheric mass. The spatial pattern of IHO is characterized by antiphase extratropical airmass anomalies and geopotential height anomalies from the troposphere to stratosphere between the Southern and Northern Hemisphere. IHO is closely related to stronger bihemispheric low-frequency signals such as Antarctic Oscillation and Arctic Oscillation, thereby demonstrating that IHO can be interpreted as a tie in linking these two dominant extratropical circulations of both hemispheres. IHO is associated with a strong meridional teleconnection in zonal winds from the middle−high troposphere to the lower stratosphere, with the wind anomalies in the form of alternate positive−negative wavy bands extending from the Antarctic to Arctic region, which act as a possible approach to interactions between the bihemispheric atmospheric mass. It is argued that IHO-related omega angular momentum anomalies led by the extratropical atmosphere cause the meridional teleconnection of relative angular momenta, thereby giving rise to the zonal wind anomalies. The modeling of GFDL and UKMO as components of the CMIP5 project have been verified, achieving the related IHO structure shown in the present paper.

The Buffer Zone of the Quasi-Biennial Oscillation

Abstract The quasi-biennial oscillation (QBO) is a descending pattern of winds in the stratosphere that vanishes near the top of the tropical tropopause layer, even though the vertically propagating waves that drive the QBO are thought to originate in the troposphere several kilometers below. The region where there is low QBO power despite sufficient vertically propagating wave activity to drive a QBO is known as the buffer zone. Classical one-dimensional models of the QBO are ill suited to represent buffer zone dynamics because they enforce the attenuation of the QBO via a zero-wind lower boundary condition. The formation of the buffer zone is investigated by analyzing momentum budgets in the reanalyses MERRA-2 and ERA-Interim. The buffer zone must be formed by weak wave-driven acceleration and/or cancellation of the wave-driven acceleration. This paper shows that in MERRA-2 weak wave-driven acceleration is insufficient to form the buffer zone, so cancellation of the wave-driven acceleration must play a role. The cancellation results from damping of angular momentum anomalies, primarily due to horizontal mean and horizontal eddy momentum flux divergence, with secondary contributions from the Coriolis torque and vertical mean momentum flux divergence. The importance of the damping terms highlights the role of the buffer zone as the mediator of angular momentum exchange between the QBO domain and the far field. Some far-field angular momentum anomalies reach the solid Earth, leading to the well-documented lagged correlation between the QBO and the length of day.

Role of Stochastic Atmospheric Forcing from the South and North Pacific in Tropical Pacific Decadal Variability

Abstract Stochastic variability of internal atmospheric modes, known as teleconnection patterns, drives large-scale patterns of low-frequency SST variability in the extratropics. To investigate how the decadal component of this stochastically driven variability in the South and North Pacific affects the tropical Pacific and contributes to the observed basinwide pattern of decadal variability, a suite of climate model experiments was conducted. In these experiments, the models are forced with constant surface heat flux anomalies associated with the decadal component of the dominant atmospheric modes, particularly the Pacific–South American (PSA) and North Pacific Oscillation (NPO) patterns. Both the PSA and NPO modes induce basinwide SST anomalies in the tropical Pacific and beyond that resemble the observed interdecadal Pacific oscillation. The subtropical SST anomalies forced by the PSA and NPO modes propagate to the equatorial Pacific mainly through the wind–evaporation–SST feedback. This atmospheric bridge is stronger from the South Pacific than the North Pacific due to the northward displacement of the intertropical convergence zone and the associated northward advection of momentum anomalies. The equatorial ocean dynamics is also more strongly influenced by atmospheric circulation changes induced by the PSA mode than the NPO mode. In the PSA experiment, persistent and zonally coherent wind stress curl anomalies over the South Pacific affect the zonal mean depth of the equatorial thermocline and weaken the equatorial SST anomalies resulting from the atmospheric bridge. This oceanic adjustment serves as a delayed negative feedback and may be important for setting the time scales of tropical Pacific decadal variability.

Stock Market Liquidity and the Trading Costs of Asset Pricing Anomalies

Using a large database of the US institutional investors’ trades, this paper revisits the question of anomalies-based portfolio transaction costs. The real costs paid by large investors to implement the well-identified size, value, and momentum anomalies are lower than what has been documented in the previous studies. We find that the average investor pays an annual transaction cost of 17bps for size, 24bps for value, and 274bps for momentum. The three strategies generate statistically significant returns of respectively 5.21%, 2.79% and 2.77% after accounting for transaction costs. When the market impact is taken into account, transaction costs reduce substantially the profitability of the well-known anomalies for large portfolios, however, these anomalies remain profitable for average size portfolios. The break-even capacities in terms of fund size are $ 206 billion for size, $ 16.1 billion for value and $ 310 million for momentum.