Momentum in Style Portfolios: Risk or Inefficiency?

Abstract

Momentum is a pervasive asset-pricing anomaly that has been shown to exist in a number of markets and asset classes. Three possible explanations for momentum have emerged in the literature; risk, positive autocorrelation and negative cross-serial correlation. Lewellen (2002) adds to this literature by providing evidence of strong momentum returns in style portfolios that can be explained by negative cross-serial correlation. However, a critique of this explanation by Chen and Hong (2002) argues that it is driven by the methodology used to decompose momentum returns and the in-sample negative autocorrelation within the market. Our paper examines style momentum in a market that exhibits positive auto-correlation across our sample period. We use an alternative empirical framework and test whether style momentum may be explained by different phenomena when the formation and investment periods are varied. We report no evidence to support negative cross-serial correlation but evidence to support momentum in style portfolios that can be explained by autocorrelation over short horizons, supporting the under-reaction hypothesis. However, we show that autocorrelation decreases when longer periods are used to form portfolios, resulting in expected returns substantively explaining returns over a 12-month horizon.