Abstract
It is well established that recent prior winner and loser stocks exhibit return continuation; a momentum
strategy of buying recent winners and shorting recent losers appears profitable in the post 1945 era. In
contrast, the risk exposure of such a strategy has not been well understood; the strategy’s unconditional
average risk exposure can be deceptive. The stock selection method of a momentum strategy guarantees
that large and time varying factor exposures will be borne in accordance with the performance of the
common risk factors during the periods in which stocks were ranked to determine their winner/loser
status. Because the factors themselves display trivial momentum, extreme factor realizations induce
noise which obscures the study of the momentum phenomenon. This noise is penetrated in two ways.
First, measurements of the factor exposure of momentum strategies are made during both formation and
investment periods. Raw returns to the strategies are adjusted for factor risk with two striking results:
the momentum phenomenon is remarkably stable across subperiods in the entire time series of post 1926
stock returns; and factor models can explain around ninety-five percent of the variability of returns on
portfolios of the top and bottom ten percent of prior winners and losers, but cannot explain their mean
returns. Second, alternative momentum strategies are studied which base winner or loser status on
stock-specific return components over some ranking period. Such strategies are more profitable than
those based on total returns. Evidence is also presented that neither industry effects nor cross-sectional
differences in expected returns are the primary cause of the observed momentum phenomenon.