Purified Stock Momentum with Crash Suppression

Posted in Momentum Investing

 

Does purifying stock returns (by using only the parts of returns unexplained by the Fama-French market, size and value factors) improve momentum strategy performance? Does avoiding extreme losers that may sharply reverse further enhance performance? In their November 2012 paper entitled “Some Simple Tricks to Boost Price Momentum Performance”,¬†Andrew Lapthorne, Rui Antunes, John Carson, Georgios Oikonomou, Charles Malafosse and Michael Suen investigate the effects on stock momentum strategy performance of:

  • Ranking stocks on cumulative lagged residual (idiosyncratic) rather than raw total return, with residual return calculated monthly as that unexplained by one-factor (market) or three-factor (plus size and book-to-market ratio) models based on 36-month lagged rolling regressions, and alternatively adjusting residual returns for each stock by dividing by their volatilities.
  • Avoiding distressed stocks that may be about to recover sharply, with distress measured as the percentage by which a stock’s current price is below its rolling lagged 12-month high.

They define momentum strategy performance as the return on a portfolio that is each month long (short) the tenth of stocks with the highest (lowest) cumulative residual returns over the past 12 months, with a skip-month between ranking interval and portfolio formation month. Using total returns in U.S. dollars and other data for FTSE World Index stocks, and contemporaneous regional Fama-French model factors, during June 1993 through September 2012, they find that: (more…)

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