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A reexamination of factor momentum: how strong is it?

Journal: The Financial Review

Date: 2022

Author: Minyou Fan, Youwei Li, Ming Liao, Jiadong Liu

Abstract:
Recent studies show that most financial market anomalies exhibit a momentum effect. Based on two datasets, (i) an original 22-factor sample and (ii) a more comprehensive 187-factor sample, we find that factor momentum effect is weak at the individual factor level. In both samples, only about 22%-27% of the factors exhibit strong return continuation and dominate the factor momentum portfolio while the remaining factors do not. The factor momentum strategies do not outperform the corresponding long-only strategies in either sample. The choice of factors affects the ability of factor momentum to explain individual stock momentum.

Link: Google Scholar

Background and Context

Study Overview

The research examines factor momentum - a trading strategy that buys recent top-performing factors and shorts poorly performing factors - using two datasets of 22 and 187 financial market factors.

Research Focus

The study investigates whether factor momentum effect is truly pervasive across individual factors or concentrated in specific factors, challenging previous findings that suggested broad applicability.

Methodology

Analysis combines factor return data from multiple sources and employs three testing approaches: abnormal returns analysis, time series testing, and spanning regressions to evaluate factor momentum strength.

Limited Prevalence of Strong Factor Momentum Effect

  • Only 27% of factors in EL sample and 22% in HXZ sample show strong momentum effect
  • Majority of factors do not exhibit significant return continuation
  • Challenges previous assumptions about pervasiveness of factor momentum

Superior Performance of Return Continuation Factors (RCFs)

  • RCFs generate significantly higher returns (6.43%) compared to non-RCFs (3.07%)
  • RCFs outperform the full sample portfolio (4.07%)
  • Demonstrates concentration of momentum effect in specific factors

Category-wise Distribution of Factor Momentum Effect

  • Value-Growth category shows strongest momentum effect (44% significant RCFs)
  • Momentum category shows weakest effect (5% significant RCFs)
  • Substantial variation in momentum effect across factor categories

BAB Factor Dominance in Return Contribution

  • BAB factors contribute 25% of total factor momentum profits
  • US BAB (13.68%) and Global BAB (11.40%) are dominant contributors
  • Highlights importance of weighting scheme in factor construction

Buy-and-Hold vs Factor Momentum Strategy Performance

  • Buy-and-hold strategy generally outperforms factor momentum
  • Only Value-Growth and Frictions categories show higher FMOM returns
  • Questions practical value of factor momentum trading strategy

Contribution and Implications

  • Factor momentum is not pervasive across all factors but concentrated in specific Return Continuation Factors (RCFs)
  • The choice of factors significantly affects the ability to explain individual stock momentum
  • Simple buy-and-hold strategies generally outperform factor momentum trading approaches
  • BAB factors' strong performance is linked to their unique rank-weighting scheme rather than inherent momentum

Data Sources

  • RCF Distribution Chart: Based on data from Tables 5 and 6
  • Performance Comparison Chart: Based on data from Table 9
  • Category Distribution Chart: Based on data from Table 6
  • BAB Contribution Chart: Based on data from Table 3
  • Strategy Comparison Chart: Based on data from Table 10