BFS 2002 |
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Contributed Talk |
Jacob Sagi, Mark Seasholes
This paper argues that the profitability of
momentum strategies can be tied to the dynamics
of firm-specific factors. We frame our argument
within a model and test its predictions. We show
that momentum can exist when the log market value
of equity is increasing and convex (or decreasing
and concave) with respect to the log price of the
commodity produced by the firm. The addition of
growth options will increase the convexity, and
thus the profits from a momentum strategy.
Costs, on the other hand, decrease convexity and
lower momentum. The first contribution of this
paper is that our model produces testable
hypotheses that are largely borne out in the
data. The most convincing evidence in favor of
our theory is that, as predicted by the model,
a momentum strategy implemented in a subsample
of low cost-leverage or high market-to-book firms
produces significantly greater returns than a
momentum strategy implemented in a subsample of
high cost-leverage or low market-to-book firms.
The second contribution of this paper is that it
ties the microeconomics of the firm to asset
pricing. Although momentum might arise under
different scenarios, we argue and present
evidence that it can be traced directly to
firm-specific factors.