A Flexible Theory of Price Momentum

Abstract

This article attempts to integrate complex and perhaps irrational investor reaction to price change into a formal model encompassing observed worldwide variations in price momentum. We review the theoretical and empirical underpinnings of price momentum in the U.S. and worldwide, observing that efforts to link or explain price momentum using other factors or risk measures generally fail, leaving an unexplained but statistically real phenomenon. Unlike value concepts which are found to work worldwide in the obvious high-relative-value-implies-excess-return way, price momentum seems to vary from country to country, seemingly defying any logical explanation. Worldwide, we observe that price momentum differs from country to country with regional themes suggesting that it is a cultural phenomenon. Using a collection of stylized outlier behaviors, we develop a story and simple model linking price momentum to perceived future attractiveness, based on traditional value ideas. A number of testable hypotheses, most confirmed by empirical work, flow from this model.