AQR – Cliff’s Perspective: Fama on Momentum

Date of Source: 05 Feb 2016

Summary:
The long-term success of the momentum factor seems to be a challenge to many observers. People say things like “momentum only works among small stocks” or “momentum only works for going short, not long.” These comments, which appear to be aimed at casting doubt on the implementability of momentum, seem to be spoken about more than written. There’s a reason for that. When you run the numbers, these statements are just not close to true. We’ve disproven a whole gaggle of them here. But, like many misperceptions, once in the zeitgeist they remain hard to kill. […]

Editor’s Analysis:
According to Eugene Fama, momentum is “the biggest embarrassment” to the Efficient Market Hypothesis (EMH) out there. Following Mark M. Carhart’s 1997 entitled “On Persistence in Mutual Fund Performance”, momentum was canonically accepted as the fourth Fama-French (FF) factor. While (FF) is now up to five factors, momentum was abandoned due its non-congruence with EMH. It momentum is indeed really real, and it cannot be explained as having costs or risks which offset its expected return spread, then it does indeed look like a “classical free lunch”. Economists can’t just be having free lunches — their mere existence turns every classical theory of human economic behavior on its head. It’s almost as if the arbitrage implied by the expected return spread on portfolios constructed according to prior returns is a slippery slope which they fear will turn into a greased precipice. I can almost visualize a wire-framed, crotchety economist slovenly stooped over a neatly stacked pile of books to peer out to the university lawn — for no particular reason other than aesthetics — from the shabbily curtained window of his musky, dimly lit office — smelling of aftershave, old books, mahogany, and dead skin — muttering in a wild-eyed fashion, “if we let ’em have free lunches, soon they’ll take everything we built, and before you know it there will be bedlam! Bedlam in the markets! Bedlam in the streets! Bedlam in the hills! Bedlam everywhere!”

In times such as these, I think it’s important to take a deep breath, relax, and repeat this mantra with me: “even good hypotheses are not reality, even good hypotheses are not reality…” And so on, ad nauseam until you can honestly look in the mirror and admit that you’re honestly “gud wit’ it”.

Blog Post Source: Cliff Asness. Fama on Momentum. AQR – Cliff’s Perspective. 05 Feb 2016. Original content accessible: https://www.aqr.com/cliffs-perspective/fama-on-momentum

Image attribution: http://www.safehaven.com/article/39996/the-hurd-is-heading-for-a-cliff


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