Interaction of Short-term Stock Momentum/Reversal and Share Turnover

Do informed (noise) traders drive short-term stock return momentum (reversal)? In their April 2018 paper entitled “Short-term Momentum”, Mamdouh Medhat and Maik Schmeling investigate interaction of short-term momentum/reversal and recent share turnover for U.S. and international stocks. They define share turnover as prior-month trading volume divided by number of shares outstanding. Specifically, they consider four portfolios:

1. Conventional short-term reversal: Each month go long (short) the value-weighted tenth, or decile, of stocks with the lowest (highest) prior-month returns.
2. Conventional momentum: Each month go long (short) the value-weighted decile of stocks with the highest (lowest) returns from 12 months ago to one month ago.
3. Modified short-term reversal (short-term reversal*): Each month go long (short) the value-weighted decile of stocks with the lowest (lowest) share turnovers within in the presorted decile of stocks with the lowest (highest) prior-month returns. [Long and short sides are reversed from those in the paper so that the expected portfolio return is positive.] 
4. Short-term momentum: Each month go long (short) the value-weighted decile of stocks with the highest (highest) share turnovers within in the presorted decile of stocks with the highest (lowest) prior-month returns.

In other words, they pick stocks for portfolios 3 and 4 by first sorting into deciles based on prior-month return and then sorting each of these deciles into nested deciles sorted based on share turnover. Using data for a broad sample of U.S. common stocks since July 1962 and common stocks in 22 developed markets since January 1993, both through December 2016, they find that: (more…)