Fama French: momentum lacks theoretical motivation

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Seasonal
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Fama French: momentum lacks theoretical motivation

Post by Seasonal » Mon Oct 07, 2019 7:10 pm

Am I reading this correctly: "Fama-French on #momentum: "We include momentum factors (somewhat reluctantly) now to satisfy insistent popular demand. We worry, however, that opening the game to factors that seem empirically robust but lack theoretical motivation has a destructive downside...” JFE2018"

https://twitter.com/paradoxinvestor/sta ... 1394102272

Note the Cliff Asness replies, including "It's outrageous and particularly galling given their theoretical risk-based justification for profitablity, i.e., "it's in the present value equation" is sort of nonsense. Upsetting."

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Re: Fama French: momentum lacks theoretical motivation

Post by Random Walker » Mon Oct 07, 2019 7:54 pm

I think you’re reading it correctly. I couldn’t open the link. Nonetheless, the original FF 3 Factor model is based on 3 risk factors. The next improvement to the model’s explanatory power was momentum. Momentum is entirely behavioral, so taking the next step to momentum is actually a leap. But the empiric data for momentum is very strong and there are logical obstacles to arbitraging the anomaly away. So for efficient market strong believers, momentum is tough to swallow but hard to deny.

Asness I think is the one who convinced Fama that momentum is real. I think his remark is sarcasm: the risk based story for profitability is I think a little tenuous.

Dave

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Re: Fama French: momentum lacks theoretical motivation

Post by willthrill81 » Mon Oct 07, 2019 8:07 pm

The theoretical justification seems quite simple to me: most market participants believe that trends are real and usually act in accordance with them. It then becomes a self-fulfilling prophecy.

I don't see why this should bother Fama. He's on record saying "We know that markets are not (perfectly) efficient; that's just the model."

In the linked interview above, Thaler said this: "The distinction I make is whether behavior is predictable for a rational model. And I'm willing to include behavior that is not predicted by a rational model."

Fama replied: "Oh, no, okay, I would agree with that."
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Re: Fama French: momentum lacks theoretical motivation

Post by happenstance » Mon Oct 07, 2019 8:08 pm

Link to the full paper, and the quote is from page 7: https://papers.ssrn.com/sol3/papers.cfm ... id=2668236. I tried reading the paper, but it's a bit over my head (comparing models using statistical tests), but the full quote is:
Thorny issues arise for factors that have no theoretical motivation but are robust in out-of-sample
tests. Without a model that identifies the forces responsible for a meaningful pattern in observed returns,
it’s hard to assess the likelihood that the pattern will persist. One might draw a line in the sand and exclude
such factors, even when they enhance model performance. The models in previous versions of this paper,
for example, exclude momentum factors. We include momentum factors (somewhat reluctantly) now to
satisfy insistent popular demand. We worry, however, that opening the game to factors that seem
empirically robust but lack theoretical motivation has a destructive downside – the end of discipline that
produces parsimonious models and the beginning of a dark age of data dredging that produces a long list
of factors with little hope of sifting through them in a statistically reliable way.

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Re: Fama French: momentum lacks theoretical motivation

Post by willthrill81 » Mon Oct 07, 2019 8:17 pm

happenstance wrote:
Mon Oct 07, 2019 8:08 pm
Link to the full paper, and the quote is from page 7: https://papers.ssrn.com/sol3/papers.cfm ... id=2668236. I tried reading the paper, but it's a bit over my head (comparing models using statistical tests), but the full quote is:
Thorny issues arise for factors that have no theoretical motivation but are robust in out-of-sample
tests. Without a model that identifies the forces responsible for a meaningful pattern in observed returns,
it’s hard to assess the likelihood that the pattern will persist. One might draw a line in the sand and exclude
such factors, even when they enhance model performance. The models in previous versions of this paper,
for example, exclude momentum factors. We include momentum factors (somewhat reluctantly) now to
satisfy insistent popular demand. We worry, however, that opening the game to factors that seem
empirically robust but lack theoretical motivation has a destructive downside – the end of discipline that
produces parsimonious models and the beginning of a dark age of data dredging that produces a long list
of factors with little hope of sifting through them in a statistically reliable way.
This quote seems to be a fitting response.

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Re: Fama French: momentum lacks theoretical motivation

Post by lazyday » Mon Oct 07, 2019 8:27 pm

Cross sectional momentum as a risk factor makes more sense to me than profitability or quality as a risk factor.

Say an active investor has a 10% position in Microsoft. They would like to increase it, but don’t because of concentration risk. Microsoft has a surprising success with a new product, the stock does well, and the position is now 15%. The investor thinks MSFT is cheap, but sells some for diversification reasons. Similar story in reverse if the stock underperforms.

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Re: Fama French: momentum lacks theoretical motivation

Post by Seasonal » Tue Oct 08, 2019 5:31 am

Digestion: there are very real dangers of data mining when trying to model investments. With digestion, there are a lot more data and there's the opportunity to run controlled experiments. It's not really a fitting response.

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Re: Fama French: momentum lacks theoretical motivation

Post by columbia » Tue Oct 08, 2019 5:32 am

Even if it is a “real” factor, another term should be used to describe/name said factor.
Last edited by columbia on Tue Oct 08, 2019 5:38 am, edited 1 time in total.

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Re: Fama French: momentum lacks theoretical motivation

Post by Forester » Tue Oct 08, 2019 5:36 am

In which "factor" is risk proven ?

Momentum - nope

Value - nope

Low volatility - BIG nope

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Re: Fama French: momentum lacks theoretical motivation

Post by Workable Goblin » Tue Oct 08, 2019 2:00 pm

Seasonal wrote:
Tue Oct 08, 2019 5:31 am
Digestion: there are very real dangers of data mining when trying to model investments. With digestion, there are a lot more data and there's the opportunity to run controlled experiments. It's not really a fitting response.
Perhaps, but that still doesn't mean that we should simply dismiss empirically-suggested relations in favor of only allowing those with a firm theoretical background. I can think of a half-dozen examples from physics and astronomy off the top of my head where there was some model or relationship noted at a certain point in time that proved empirically well-founded even though there was no theoretical explanation for it until much later, if one even exists today. For that matter, the calculus--yes, of Newton and Leibniz--was mainly justified by the fact that it worked until the development of proper real analysis in the 19th century, nearly two hundred years after it was first developed! It seems incredible to me to be demanding more rigorous adherence to theoretical justification in a social science like economics than is demanded in physical sciences or even mathematics.

In any case, the idea that one should dismiss relations that pop up in the data if they don't have some kind of theoretical underpinning strikes me as an extremely Aristotelian view that's out of date by at least five hundred years or so. It's true that just assuming every relationship that shows up when you do a data analysis is real is a good way to get into trouble, but it's necessary to at least take them seriously, look at their degree of statistical significance and other factors relative to the sample size, and try to think of any theoretical explanations that might support the existence of this relationship. Obviously, if some relationship proves resilient against multiple investigators, which I understand "momentum" to have done, then that is also a significant flag that it might be a real relationship and not just some statistical artifact. As such, the focus really should be on finding a reasonable theoretical underpinning for momentum as a real factor rather than just dismissing it because it doesn't fit into our existing schema.

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Re: Fama French: momentum lacks theoretical motivation

Post by cheezit » Tue Oct 08, 2019 2:13 pm

Forester wrote:
Tue Oct 08, 2019 5:36 am
In which "factor" is risk proven ?

Momentum - nope

Value - nope

Low volatility - BIG nope
RandomWalker and I were bouncing around on this topic in another recent thread (can't seem to recall which).

While I don't see how anyone would truly prove the origin of a given factor's premium, at least for me it's easy to see how Size and Value could be mostly risk-based. It's much harder to see quality (AQR) or profitability and investment (F-F) as mostly risk-based, and I can't for the life of me see how BaB(AQR)/LowVol or either type of Momentum has any basis in unique risk as opposed to behavioral factors/mispricing.

Of course, the origin may not matter that much. While markets are getting more efficient all the time and quantitative trading will only get better at exploiting and eventually arbitraging away mispricings, there are still limits to these effects.

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Re: Fama French: momentum lacks theoretical motivation

Post by willthrill81 » Tue Oct 08, 2019 2:27 pm

Workable Goblin wrote:
Tue Oct 08, 2019 2:00 pm
Seasonal wrote:
Tue Oct 08, 2019 5:31 am
Digestion: there are very real dangers of data mining when trying to model investments. With digestion, there are a lot more data and there's the opportunity to run controlled experiments. It's not really a fitting response.
Perhaps, but that still doesn't mean that we should simply dismiss empirically-suggested relations in favor of only allowing those with a firm theoretical background. I can think of a half-dozen examples from physics and astronomy off the top of my head where there was some model or relationship noted at a certain point in time that proved empirically well-founded even though there was no theoretical explanation for it until much later, if one even exists today. For that matter, the calculus--yes, of Newton and Leibniz--was mainly justified by the fact that it worked until the development of proper real analysis in the 19th century, nearly two hundred years after it was first developed! It seems incredible to me to be demanding more rigorous adherence to theoretical justification in a social science like economics than is demanded in physical sciences or even mathematics.

In any case, the idea that one should dismiss relations that pop up in the data if they don't have some kind of theoretical underpinning strikes me as an extremely Aristotelian view that's out of date by at least five hundred years or so. It's true that just assuming every relationship that shows up when you do a data analysis is real is a good way to get into trouble, but it's necessary to at least take them seriously, look at their degree of statistical significance and other factors relative to the sample size, and try to think of any theoretical explanations that might support the existence of this relationship. Obviously, if some relationship proves resilient against multiple investigators, which I understand "momentum" to have done, then that is also a significant flag that it might be a real relationship and not just some statistical artifact. As such, the focus really should be on finding a reasonable theoretical underpinning for momentum as a real factor rather than just dismissing it because it doesn't fit into our existing schema.
:thumbsup Very well said.

Much academic research has examined momentum, and it's pretty much a resolved matter in the finance literature that momentum is a very real factor. It has been demonstrated to exist across asset classes (not just stocks), geography, and time. The only real resistance to it is because it flies in the face of the efficient market hypothesis, but if the data strongly suggest that a theory is not correct, we should be more dismissive of the theory than the data. And even Fama himself has noted that the EMH is "just a model" and not absolutely accurate.

"A scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die and a new generation grows up that is familiar with it."
-Max Planck
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Re: Fama French: momentum lacks theoretical motivation

Post by willthrill81 » Tue Oct 08, 2019 2:29 pm

Forester wrote:
Tue Oct 08, 2019 5:36 am
In which "factor" is risk proven ?

Momentum - nope

Value - nope

Low volatility - BIG nope
It makes me think of this.

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Re: Fama French: momentum lacks theoretical motivation

Post by garlandwhizzer » Tue Oct 08, 2019 4:12 pm

As for the explanations for why a factor works there are some contradictions. At least part of the explanation for the existence of the small and value factors is the increased risk of these stocks which are more vulnerable economically. On the other hand there is a Low Vol factor and a Qual factor which have done quite nicely in recent years and these stocks clearly take on lower risk, are less subject to severe declines in a down market, and have been rewarded for taking on less risk. For small and value more risk seems to lead to greater long term returns. For Low Vol and Qual, less risk leads to higher long term returns. It seems that risk itself works in opposite direction to explain factor results depending on circumstances.

It's important to remember that explanations for why things work or don't work are always made up post-facto. Back in the heydays of growth investing during the multi-year the tech boom of the 1990s, the argument was made by growth investors that it was entirely rational for the growth stocks to be sold at outrageous PE, PB, etc., because their increased rate of profit growth would more than overcome their current high valuations relative to the slow growth dirt cheap stocks in the future. Greenspan saw this "irrational exuberance" in 1997 and warned the market about it. The leading explanation offered by growth investors to counter this was that it was entirely rational to buy a rapidly growing company with a convincing narrative for future profit growth at a ridiculous valuation. Its increased growth prospects would make it a bargain at any price in the future. This argument ruled the market during the entire tech run up and was not seriously questioned during the next 3 years after Greenspan's warning which seemed more and more to be Chicken Little shouting that the sky was falling. The same outrageous valuations happened recently for Amazon, Netflix, Tesla, Uber, Beyond Meat, etc., which, unlike Apple and Facebook which have real robust profits, got their sky high valuations while they burned through cash and produced meager or hugely negative profits. Again, the same explanation, they're going to grow so much that current price doesn't matter. At last such stocks have begun to run into reality and some are beginning to question the growth explanation.

Factors are derived by data mining pure and simple. If the numbers work explanations appear. Whether they will perform up to past exceptions in the future is an unknown IMO. Perhaps, perhaps not. The models that create them are not realistic and the future is not the past. Explanations for why they work do not seem consistently reliable which is I believe what Fama is talking about. After something happens people find a host of reasons to explain why, but as the above risk example shows, there may not logical consistency in these explanations.

There is the question of human behavioral bias to explain factors like MOM. It is totally plausible that human nature might want to sell something that is declining rapidly in value and to buy something that is rapidly appreciating in value. Seems to be a totally behavioral explanation. On the other hand following this strategy you tend to be buying stocks that are the opposite of value, stocks whose price appreciation is based not on fundamentals but on herd exuberance which may be irrational. Harvesting MOM fully at the same time diminishes Val and diminishes MOM's opposite Low Vol. What is the the net effect on the portfolio of increasing this one factor (MOM) while decreasing the other two Val and Low Vol? Questions like this may be one reason why multi-factor portfolios have to date produced disappointing results. It's a lot easier to get great results on factor backtesting if you optimize all these decisions to suit your chosen time frame in the rear view mirror. Low Vol works because you buy stocks that move less than the market in both directions. MOM works because you buy stocks that are moving more than the market in both directions, being the gainers and selling the losers. Again, the exact opposite effect from the same basic thing. I believe these factor explanatory contradictions bother Fama who believes that risk carries a real premium which is entirely rational but questions some of the other explanations which rely more on human emotional makeup.

A for behavioral explanations, 90% of all stock trades now are not done by mom and pop riding an emotional roller coaster but rather by highly paid professionals who in theory at least should be less swayed by MOM herd action. Computer algorithms do more and more trading volume every year and presumably computers aren't driven by emotional swings. Finally AI (the combination of extremely deep constantly updated data base with extreme computing power) is likely to revolutionize factor investing. My suspicion is that AI will be able to design factor portfolios, both single and multi-factor, better than humans. All new data is instantly fed into the deepest data base available, the computer with vast power reads it instantly and makes changes as appropriate in real time. It was in this way that an AI program defeated the world champion chess player. The computer lost the first few games but learned from and corrected its mistakes in real time and soon began to win consistently. In the end, the world champion, knowing the outcome, didn't want to play any more. I believe the same will happen with factor investing. There is a real possibility that when this happens, probably a lot sooner than many expect, that factors will be so efficiently targeted that in time they may get arbitraged away.

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Re: Fama French: momentum lacks theoretical motivation

Post by Northern Flicker » Tue Oct 08, 2019 5:10 pm

I can’t answer whether or not there is a momentum factor, but it is my opinion that research on the (time series) momentum factor is the most flawed of any of the factor research. To answer the question, you have to commit, before looking at the data, to a hypothesis that securities that have increased faster than the market for time period N will continue to do so for time M, at which point a new set of securities purported to have momentum will be identified.

Have you ever heard any investment researcher or investment professional mention N and M when touting the benefit of momentum? Of course, they can’t because if that were publicly known, then it will be susceptible to front running.
Risk is not a guarantor of return.

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Re: Fama French: momentum lacks theoretical motivation

Post by Seasonal » Tue Oct 08, 2019 5:51 pm

Workable Goblin wrote:
Tue Oct 08, 2019 2:00 pm
Seasonal wrote:
Tue Oct 08, 2019 5:31 am
Digestion: there are very real dangers of data mining when trying to model investments. With digestion, there are a lot more data and there's the opportunity to run controlled experiments. It's not really a fitting response.
Perhaps, but that still doesn't mean that we should simply dismiss empirically-suggested relations in favor of only allowing those with a firm theoretical background. I can think of a half-dozen examples from physics and astronomy off the top of my head where there was some model or relationship noted at a certain point in time that proved empirically well-founded even though there was no theoretical explanation for it until much later, if one even exists today. For that matter, the calculus--yes, of Newton and Leibniz--was mainly justified by the fact that it worked until the development of proper real analysis in the 19th century, nearly two hundred years after it was first developed! It seems incredible to me to be demanding more rigorous adherence to theoretical justification in a social science like economics than is demanded in physical sciences or even mathematics.

In any case, the idea that one should dismiss relations that pop up in the data if they don't have some kind of theoretical underpinning strikes me as an extremely Aristotelian view that's out of date by at least five hundred years or so. It's true that just assuming every relationship that shows up when you do a data analysis is real is a good way to get into trouble, but it's necessary to at least take them seriously, look at their degree of statistical significance and other factors relative to the sample size, and try to think of any theoretical explanations that might support the existence of this relationship. Obviously, if some relationship proves resilient against multiple investigators, which I understand "momentum" to have done, then that is also a significant flag that it might be a real relationship and not just some statistical artifact. As such, the focus really should be on finding a reasonable theoretical underpinning for momentum as a real factor rather than just dismissing it because it doesn't fit into our existing schema.
If a hypothesis lacks a firm theoretical basis it should have a solid empirical basis. Physics and astronomy (like the study of digestion in the post I was responding to) are hard sciences, with lots of data and the opportunity to run controlled experiments (or, at least, experiments - we can't place Mercury where we want it, but we can observe light bending around it).

We have nowhere near that amount or quality of data for investments, including examinations of momentum. We have a limited number of years and an even smaller number of independent multi-year periods. Conditions generating returns may change over time, further reducing the amount and relevance of our data. We cannot run realistic controlled experiments.

A standard way to do analysis is to form a hypothesis and then test it; to do otherwise risks data mining. Momentum does not appear to be a product of that type of process.

Momentum appears to lack a firm theoretical basis and, like just about everything in this field, lacks adequate empirical support.

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Re: Fama French: momentum lacks theoretical motivation

Post by willthrill81 » Tue Oct 08, 2019 6:13 pm

Seasonal wrote:
Tue Oct 08, 2019 5:51 pm
Momentum appears to lack a firm theoretical basis and, like just about everything in this field, lacks adequate empirical support.
I agree that we need better theories in finance and more data. But unfortunately, stating that we need them does nothing to help us acquire them. Investors have to make decisions with the data in front of them. Some believe that total market indices are best position, others strongly favor factors, and still others have a mix of both. None are definitively right or wrong.

"Do what you can, with what you have, where you are."
-Theodore Roosevelt

P.S. I don't often use quotes in my posts, but they just seem fitting in this thread.
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Re: Fama French: momentum lacks theoretical motivation

Post by Forester » Tue Oct 08, 2019 6:21 pm

Seasonal wrote:
Tue Oct 08, 2019 5:51 pm
We have nowhere near that amount or quality of data for investments, including examinations of momentum. We have a limited number of years and an even smaller number of independent multi-year periods. Conditions generating returns may change over time, further reducing the amount and relevance of our data. We cannot run realistic controlled experiments.

A standard way to do analysis is to form a hypothesis and then test it; to do otherwise risks data mining. Momentum does not appear to be a product of that type of process.

Momentum appears to lack a firm theoretical basis and, like just about everything in this field, lacks adequate empirical support.
Cowles & Jones observed that winners continue to win, in the 1930s. I'm not aware of any momentum study in the meantime that's found otherwise. The controversy is whether these are simply paper profits and cannot be replicated in a live fund.

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Re: Fama French: momentum lacks theoretical motivation

Post by columbia » Tue Oct 08, 2019 6:25 pm


There is a real possibility that when this happens, probably a lot sooner than many expect, that factors will be so efficiently targeted that in time they may get arbitraged away.

This seems likely (assuming trading costs can be sufficiently minimized).

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Re: Fama French: momentum lacks theoretical motivation

Post by firebirdparts » Tue Oct 08, 2019 9:08 pm

Momentum cannot be arbitraged, and that may be an extra reason they wish they could ignore it.

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Re: Fama French: momentum lacks theoretical motivation

Post by stlutz » Tue Oct 08, 2019 10:38 pm

firebirdparts wrote:
Tue Oct 08, 2019 9:08 pm
Momentum cannot be arbitraged, and that may be an extra reason they wish they could ignore it.
Sure it can. Momentum is basically an illustration that stock prices have adjusted to fundamental and economic changes too slowly. if investors buy faster and bring prices to their "proper" value more quickly, then momentum will no longer exist.

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Re: Fama French: momentum lacks theoretical motivation

Post by stlutz » Tue Oct 08, 2019 10:47 pm

Increasingly my own conclusion is that pretty much all of the various "factors" are more demonstrations of lower-risk securities outperforming, rather than higher ones. Low vol and "quality" are obvious in that regard. I think momentum fits the bill as well--it is less risky to invest in a company that is doing well than one that might go bankrupt in the next 6 months. I also think value does--it's intuitively less risky to pay 15x for a stream of earnings than to pay 30x--a lot more has to go right for the later investment to work out.

So, the question [for me] becomes whether this is something intrinsic to markets--could be a rational reason or behavioral error--or if the market has historically just gotten it wrong. Factor research may just be helping the market price risk more accurately going forward.

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Re: Fama French: momentum lacks theoretical motivation

Post by Northern Flicker » Tue Oct 08, 2019 11:04 pm

Certainly a substantial part of the historical outperformance of small caps was a liquidity risk premium when trading was more primitive and “over the counter” meant something. Deep value also was historically much less liquid than today. Hard to say how much of the historical premia of these factors will disappear from improved liquidity.
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Re: Fama French: momentum lacks theoretical motivation

Post by willthrill81 » Tue Oct 08, 2019 11:56 pm

stlutz wrote:
Tue Oct 08, 2019 10:38 pm
firebirdparts wrote:
Tue Oct 08, 2019 9:08 pm
Momentum cannot be arbitraged, and that may be an extra reason they wish they could ignore it.
Sure it can. Momentum is basically an illustration that stock prices have adjusted to fundamental and economic changes too slowly.
You're creating a theory here as to why momentum exists, not describing the nature of momentum itself (i.e. 'winners' tend to keep 'winning' and vice versa for 'losers'). This theory may be right, and it might be wrong.

Another theory for momentum is that trends in prices are, to some degree, 'self'-perpetuating by market participants. This is completely distinct from the theory you've put forward.

I don't know whether either of these theories is correct. But if the latter is true, then momentum cannot be 'arbitraged away'.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Fama French: momentum lacks theoretical motivation

Post by firebirdparts » Wed Oct 09, 2019 9:54 pm

stlutz wrote:
Tue Oct 08, 2019 10:38 pm
firebirdparts wrote:
Tue Oct 08, 2019 9:08 pm
Momentum cannot be arbitraged, and that may be an extra reason they wish they could ignore it.
Sure it can. Momentum is basically an illustration that stock prices have adjusted to fundamental and economic changes too slowly. if investors buy faster and bring prices to their "proper" value more quickly, then momentum will no longer exist.
Nope. You can try, though.

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Re: Fama French: momentum lacks theoretical motivation

Post by taojaxx » Wed Oct 09, 2019 10:03 pm

Fun discussion for an agnostic investor. Basically boils down to "it works in practice, but how does it work in theory?". And in social science, at that. :?

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Re: Fama French: momentum lacks theoretical motivation

Post by stlutz » Wed Oct 09, 2019 10:13 pm

willthrill81 wrote:
Tue Oct 08, 2019 11:56 pm
stlutz wrote:
Tue Oct 08, 2019 10:38 pm
firebirdparts wrote:
Tue Oct 08, 2019 9:08 pm
Momentum cannot be arbitraged, and that may be an extra reason they wish they could ignore it.
Sure it can. Momentum is basically an illustration that stock prices have adjusted to fundamental and economic changes too slowly.
You're creating a theory here as to why momentum exists, not describing the nature of momentum itself (i.e. 'winners' tend to keep 'winning' and vice versa for 'losers'). This theory may be right, and it might be wrong.

Another theory for momentum is that trends in prices are, to some degree, 'self'-perpetuating by market participants. This is completely distinct from the theory you've put forward.

I don't know whether either of these theories is correct. But if the latter is true, then momentum cannot be 'arbitraged away'.
Well, forget my "story" then. :D

The various momentum buy rules are well known. I can buy the stocks that momentum investors are about to buy according to those rules. Once they buy and drive the price up further, I (and others like me) can sell, thus aborting the momentum.

Momentum investors respond to this by shortening their momentum window. I shorten my window to front run them in response. And so forth. Until what happens is that the price movement simply happens all at once and is then over.

Most trading strategies are front-runnable, at least in theory. When that will actually happen is open to question.

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Re: Fama French: momentum lacks theoretical motivation

Post by Forester » Thu Oct 10, 2019 3:33 am

stlutz wrote:
Wed Oct 09, 2019 10:13 pm
willthrill81 wrote:
Tue Oct 08, 2019 11:56 pm
stlutz wrote:
Tue Oct 08, 2019 10:38 pm
firebirdparts wrote:
Tue Oct 08, 2019 9:08 pm
Momentum cannot be arbitraged, and that may be an extra reason they wish they could ignore it.
Sure it can. Momentum is basically an illustration that stock prices have adjusted to fundamental and economic changes too slowly.
You're creating a theory here as to why momentum exists, not describing the nature of momentum itself (i.e. 'winners' tend to keep 'winning' and vice versa for 'losers'). This theory may be right, and it might be wrong.

Another theory for momentum is that trends in prices are, to some degree, 'self'-perpetuating by market participants. This is completely distinct from the theory you've put forward.

I don't know whether either of these theories is correct. But if the latter is true, then momentum cannot be 'arbitraged away'.
Well, forget my "story" then. :D

The various momentum buy rules are well known. I can buy the stocks that momentum investors are about to buy according to those rules. Once they buy and drive the price up further, I (and others like me) can sell, thus aborting the momentum.

Momentum investors respond to this by shortening their momentum window. I shorten my window to front run them in response. And so forth. Until what happens is that the price movement simply happens all at once and is then over.

Most trading strategies are front-runnable, at least in theory. When that will actually happen is open to question.
The biggest momentum ETF, MTUM, appears to prize size & liquidity over signal. The ETF is effectively picking from the top four momentum deciles of the large cap universe. I think that would be hard to front run... you would be making money alongside MTUM, not instead of.

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