This paper discusses possible asset-specific and cross-asset explanation approaches for momentum appearance. The two main threads in literature, stock momentum and momentum of other assets, are discussed separately and subsequently checked for overlaps. The paper also deals with the definition of momentum as an anomaly itself in context of rational and behavioral concepts. It uncovers selected contrary observations and outlines possible conformities.
Capital market anomalies are a phenomenon triggering ongoing debates about the trading behavior of investors on financial markets. They are contradicting the core ideas of the efficient market hypothesis (EMH), which considers financial markets efficient and investors rational and fully informed. One of the EMH key hypotheses, especially supported by Fama and by Samuelson, is the principle of random walk.
If this principle holds, the prices of assets on financial markets are only influenced by public and firm-specific news, develop apart from that completely random and are not predictable. However, empirical observations question the random walk principle. They tend to indicate specific patterns in asset price developments instead of complete randomness. Doubts on the EMH and the random walk principle thus cannot be neglected.
A common answer to these observations is the existence of additional risk factors which are currently not covered by the applied pricing models. Current asset pricing models mainly rely on Markowitz (1952) and the modern portfolio theory as well as on the Capital Asset Pricing Model (CAPM) from Sharpe (1964), Lintner (1965), and Mossin (1966). These models are rather a benchmark for asset pricing than perfect constructions covering all and any existing risk factors which are relevant for an assets price formation.
Table of Contents
1. Introduction
2. Momentum as a Capital Market Anomaly
2.1 Evidence from Equity Markets
2.2 Evidence from other Asset Classes
3. Explanatory Approaches
3.1 Explanatory Approaches for Equity Markets
3.2 Explanatory Approaches for other Asset Classes
4. Cross-Asset Explanatory Approaches
4.1 Approaches in Accordance with the Efficient Market Hypothesis
4.2 Approaches in Accordance with Behavioral Finance
5. Transferability of Explanatory Approaches
5.1 Contrary Observations
5.2 Equal Approaches
6. Conclusion
Research Objectives and Core Topics
This paper examines the momentum effect as a significant capital market anomaly, investigating its presence across various asset classes, including stocks, commodities, currencies, and indices. The primary research objective is to analyze and contrast diverse explanatory approaches—ranging from risk-based models aligned with the Efficient Market Hypothesis to behavioral finance perspectives—to determine the potential causes of momentum returns and evaluate the existence of a global common factor driving these patterns.
- Evidence and robustness of the momentum effect across multiple asset classes.
- Analysis of rational risk-based explanations versus behavioral finance theories.
- Evaluation of underreaction and overreaction as primary drivers of momentum.
- Investigation of cross-asset similarities and regional differences in momentum patterns.
- Assessment of the transferability of explanatory models between different asset categories.
Excerpt from the Book
1. Introduction
Capital market anomalies are a phenomenon triggering ongoing debates about the trading behavior of investors on financial markets (Asness et al., 2013, p. 929). They are contradicting the core ideas of the efficient market hypothesis (EMH), which considers financial markets efficient and investors rational and fully informed. One of the EMH key hypotheses, especially supported by Fama and by Samuelson, is the principle of random walk (Fama, 1965, pp. 34ff.; Samuelson, 1965, pp. 41ff.). If this principle holds, the prices of assets on financial markets are only influenced by public and firm-specific news, develop apart from that completely random and are not predictable. However, empirical observations question the random walk principle. They tend to indicate specific patterns in asset price developments instead of complete randomness. Doubts on the EMH and the random walk principle thus cannot be neglected. A common answer to these observations is the existence of additional risk factors which are currently not covered by the applied pricing models.
Current asset pricing models mainly rely on Markowitz (1952) and the modern portfolio theory as well as on the Capital Asset Pricing Model (CAPM) from Sharpe (1964), Lintner (1965), and Mossin (1966). These models are rather a benchmark for asset pricing than perfect constructions covering all and any existing risk factors which are relevant for an assets price formation. This essay deals with the potential causes of one of the observed anomalies, the so-called momentum effect. Fama and French (2004) bring attention to the topic as they consider the momentum anomaly “the most serious problem” of their three-factor model (p. 40). This paper discusses possible asset-specific and cross-asset explanation approaches for momentum appearance, but it does not provide a final or unique answer. Although under and overreaction can be seen as key parts of the momentum explaining literature, other possible explanations can by no means be considered less important contributors.
Summary of Chapters
1. Introduction: Outlines the persistence of capital market anomalies as a challenge to the Efficient Market Hypothesis and introduces momentum as the central research subject.
2. Momentum as a Capital Market Anomaly: Defines the momentum effect and presents empirical evidence of its occurrence in both equity markets and additional asset classes like commodities and currencies.
3. Explanatory Approaches: Discusses various theoretical frameworks, separating explanations for stock-specific momentum from those applicable to other asset classes.
4. Cross-Asset Explanatory Approaches: Categorizes explanatory theories into those consistent with the Efficient Market Hypothesis and those rooted in behavioral finance.
5. Transferability of Explanatory Approaches: Critically analyzes the consistency of momentum theories, highlighting both contradictory observations and emerging common drivers across asset classes.
6. Conclusion: Summarizes the current state of momentum research, emphasizing the need for future studies to focus on future return predictability rather than historical patterns.
Keywords
Momentum, Capital Market Anomaly, Efficient Market Hypothesis, Behavioral Finance, Asset Pricing, Stock Market, Currency Momentum, Commodity Futures, Underreaction, Overreaction, Arbitrage, Risk Factors, Market Efficiency, Relative Strength, Return Predictability.
Frequently Asked Questions
What is the central focus of this research paper?
The paper focuses on the "momentum effect," an anomaly where financial assets that performed well in the past continue to generate extra profits in the subsequent period, challenging standard market theories.
Which asset classes are covered in the study?
The study investigates momentum evidence in equity markets (stocks), as well as indices, currencies, commodities, and corporate bonds.
What is the primary research goal regarding momentum explanations?
The goal is to determine if momentum can be explained by rational risk factors—consistent with the Efficient Market Hypothesis—or if it is better understood through behavioral finance and the psychological tendencies of investors.
What scientific methods are utilized to explore momentum?
The author performs an extensive literature review, synthesizing empirical findings from various financial studies to contrast different explanatory models and assess their validity across asset boundaries.
What core concepts are discussed in the main chapters?
The main chapters cover the definition of momentum as an anomaly, the distinction between underreaction and overreaction, the impact of cross-asset factors, and the challenges of transferring theories from one asset class to another.
Which keywords best characterize this work?
Key terms include momentum, Efficient Market Hypothesis, behavioral finance, asset pricing, underreaction, overreaction, and market efficiency.
How do behavioral factors like overconfidence contribute to momentum?
According to the literature discussed, overconfidence can lead investors to overestimate their private information, pushing asset prices away from their fundamental values through overreaction.
Does the author conclude that a single model explains momentum?
No, the author concludes that no unique or final explanation currently exists, noting that while there is a tendency toward a global common factor, the specific drivers remain a subject for further research.
- Arbeit zitieren
- Fabian Hertel (Autor:in), 2021, What causes Momentum Returns? Evidence from different Asset Classes, München, GRIN Verlag, https://www.hausarbeiten.de/document/1176923
