Cross‐Sectional and Time Series Momentum Returns and Market States

• DOI: http://doi.org/10.1111/irfi.12148
• Published date: 01 December 2018
• Author: Gilbert V. Nartea,Muhammad A. Cheema,Yimei Man
• Date: 01 December 2018

Cross-Sectional and Time Series

Momentum Returns and Market

States

MUHAMMAD A. CHEEMA

†

,GILBERT V. NARTEA

‡

AND YIMEI MAN

†

†

Department of Finance Waikato Management School, University of Waikato,

Hamilton, New Zealand and

‡

Department of Economics and Finance, UC Business School, University of Canterbury,

Christchurch, New Zealand

ABSTRACT

Recent evidence on momentum returns shows that the time series (TS) stra-

tegy outperforms the cross-sectional (CS) strategy. We present new evidence

that this happens only when the market continues in the same state, up or

down. In fact, we find that the TS strategy underperforms the CS strategy

when the market transitions to a different state. Our results also show that

the difference in momentum returns between TS and CS strategies is related

to both the net long and net short positions of the TS strategy.

JEL Codes: G11; G12; G14

Accepted: 18 July 2017

I. INTRODUCTION

Momentum trading strategies rely on return predictability based on past

returns with much of the early momentum literature dealing with cross-

sectional patterns, in line with studies that investigate asset pricing anoma-

lies. For example, Jegadeesh and Titman (1993) show that stocks that have

outperformed (underperformed) their peers in the past 3 to 12 months usu-

ally continue to outperform (underperform) in the next 3 to 12 months. This

has led to the so-called cross-sectional momentum strategy of buying recent

winners and short-selling recent losers relative to the cross section of stocks.

The cross-sectional momentum strategy has subsequently been shown to be

profitable in several asset classes and markets (e.g. Rouwenhorst 1998; Asness

et al. 2013).

1

More recently, Moskowitz et al. (2012) document a “time series

1 Momentum profits are apparently conditioned by business cycles (Chordia and Shivakumar

2002), market states and market dynamics (Cooper et al. 2004; Asem and Tian 2010), and mar-

ket volatility (Wang and Xu 2015). Daniel and Moskowitz (2016) show that momentum strat-

egies can also experience infrequent bouts of negative returns which are partly forecastable.

© 2017 International Review of Finance Ltd. 2017

International Review of Finance, 2017

DOI: 10.1111/irfi.12148

International Review of Finance, 18:4, 2018: pp. 705–715

DOI:10.1111/ir .12148

© 2017 International Review of Finance Ltd. 2017