Momentum pricing and trading, and economic uncertainty regimes

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The effects of momentum on excess equity returns are not constant across different regimes of economic uncertainty. They tend to decrease in high uncertainty regimes, for portfolios that do not depend significantly on prior returns, and to increase for portfolios that do depend, either negatively or positively. We used a regression framework that allows us to explore the evolving nature of momentum pricing in the context of two beta representations of the equity premium: Fama-French three and five-factor models. Here, economic uncertainty is incorporated as an economic regime that impacts the probability distribution of momentum. We also calculate pricing errors of each model under the two regimes. In general, all the models perform better during regimes of relatively high uncertainty, and those that incorporate momentum perform the best. Nevertheless, this superior performance comes at a cost. In high uncertainty regimes the abnormal returns of momentum, after controlling for the other factors in our set-up, reduce to zero, while its higher moments imply remarkable greater risks, compared to low uncertainty regimes.

Author(s):

Jorge M. Uribe    
University of Barcelona
Spain