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Penn STAT 956 - Do Industries Explain Momentum

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Do Industries Explain Momentum?Tobias J. Moskowitz; Mark GrinblattThe Journal of Finance, Vol. 54, No. 4, Papers and Proceedings, Fifty-Ninth Annual Meeting,American Finance Association, New York, New York, January 4-6, 1999. (Aug., 1999), pp.1249-1290.Stable URL:http://links.jstor.org/sici?sici=0022-1082%28199908%2954%3A4%3C1249%3ADIEM%3E2.0.CO%3B2-5The Journal of Finance is currently published by American Finance Association.Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available athttp://www.jstor.org/about/terms.html. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtainedprior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content inthe JSTOR archive only for your personal, non-commercial use.Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained athttp://www.jstor.org/journals/afina.html.Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printedpage of such transmission.JSTOR is an independent not-for-profit organization dedicated to and preserving a digital archive of scholarly journals. Formore information regarding JSTOR, please contact [email protected]://www.jstor.orgTue Apr 10 20:02:06 2007THE JOURNAL OF FINANCE VOL LIV. NO. 4 AUGUST 1999 Do Industries Explain Momentum? TOBIAS J. MOSKOWITZ and MARK GRINBLATT* ABSTRACT This paper documents a strong and prevalent momentum effect in industry com-ponents of stock returns which accounts for much of the individual stock momen-tum anomaly. Specifically,momentum investment strategies, which buy past winning stocks and sell past losing stocks, are significantly less profitable once we control for industry momentum. By contrast, industry momentum investment strategies, which buy stocks from past winning industries and sell stocks from past losing industries, appear highly profitable, even after controlling for size, book-to-market equity, individual stock momentum, the cross-sectional dispersion in mean returns, and potential microstructure influences. BOTHINVESTMENT THEORY AND ITS APPLICATION to investment management crit-ically depend on our field's understanding of stock return persistence anom-alies. Determining whether these anomalies are rooted in behavior that can be exploited by more rational investors at low risk has profound im-plications for our view of market efficiency and optimal investment policy. The ability to outperform buy-and-hold strategies by acquiring past win-ning stocks and selling past losing stocks, commonly referred to as "indi-vidual stock momentum," remains one of the most puzzling of these anomalies, both because of its magnitude (up to 12 percent abnormal return per dollar long on a self-financing strategy per year) and because of the peculiar horizon pattern that it seems to follow: Trading based on individual stock momentum appears to be a poor strategy when using a short historical horizon for portfolio formation (especially less than one month); it is highly "Moskowitz is from the Graduate School of Business, University of Chicago (tobias. [email protected]), and Grinblatt is from the Anderson School, University of Cali-fornia at Los Angeles ([email protected]).We thank Kobi Boudoukh, Ty Callahan, Kent Daniel, Gordon Delianedis, Gene Fama, Rick Green, Jonathan Howe, Narasimhan Je-gadeesh, Olivier Ledoit, Richard Roll, Pedro Santa-Clara, Rene Stulz, Sheridan Titman, Ralph Walkling, Russ Wermers, David Wessels, two anonymous referees, and seminar participants at UCLA, Yale, Harvard, Rochester, Ohio State, Wharton, Columbia, Duke, the University of Col-orado at Boulder, the University of Texas at Austin, the University of Chicago, Northwestern, the University of Michigan, the 1998 WFA meetings in Monterey, CA, the 1998 NBER Asset Pricing Conference in Chicago, and the 1999 AFA meetings in New York for valuable comments and insights. Moskowitz thanks the Center for Research in Securities Prices as well as the Dimensional Fund Advisors Research Fund for financial support. Grinblatt thanks the UCLA Academic Senate for financial support.1250 The Journal of Finance profitable at intermediate horizons (up to 24 months, although it is stron-gest in the 6- to 12-month range); and is once again a poor strategy at long horizons.1 This paper largely focuses on the positive persistence in stock returns (or momentum effect) over intermediate investment horizons (6 to 12 months) and explores various explanations for its existence. We identify industry mo-mentum as the source of much of the momentum trading profits at these horizons. Specifically, we find strong evidence that persistence in industry return components generates significant profits that may account for much of the profitability of individual stock momentum strategies. We show the following evidence: Industry portfolios exhibit significant momentum, even after control-ling for size, book-to-market equity (BE/ME), individual stock momen-tum, the cross-sectional dispersion in mean returns, and potential microstructure influences. Once returns are adjusted for industry effects, momentum profits from individual equities are significantly weaker and, for the most part, are statistically insignificant. Industry momentum strategies are more profitable than individual stock momentum strategies. Industry momentum strategies are robust to various specifications and methodologies, and they appear to be profitable even among the larg-est, most liquid stocks. Profitability of industry strategies over intermediate horizons is pre-dominantly driven by the long positions. By contrast, the profitability of individual stock momentum strategies is largely driven by selling past losers, particularly among the less liquid stocks. Unlike individual stock momentum, industry momentum is strongest in the short-term (at the one-month horizon) and then, like individual stock momentum, tends to dissipate after 12 months, eventually reversing at long horizons. Thus, the signs of the short-term (less than one month) performances of the industry and individual stock momentum strat-egies are completely opposite, yet the signs of their intermediate and long-term performances are identical. The


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