A Model of Momentum

Laura Xiaolei Liu, Lu Zhang

NBER Working Paper No. 16747
Issued in January 2011, Revised in December 2011
NBER Program(s):Asset Pricing, Corporate Finance, Economic Fluctuations and Growth

Optimal investment of firms implies that expected stock returns are tied with the expected marginal benefit of investment divided by the marginal cost of investment. Winners have higher expected growth and expected marginal productivity (two major components of the marginal benefit of investment), and earn higher expected stock returns than losers. The investment model succeeds in capturing average momentum profits, reversal of momentum in long horizons, as well as the interaction of momentum with market capitalization, firm age, trading volume, and stock return volatility. However, the model fails to reproduce procyclical momentum profits.

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Document Object Identifier (DOI): 10.3386/w16747

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