Pure momentum is priced

The paper investigates the relationship between the profitable momentum strategies and the typical factors used in asset pricing tests including investors’ sentiment. We assume that momentum profits arise from a risk factor that correlates with economic dynamics and investors’ sentiment which drive stock prices. We use univariate and multivariate two-state Markov regime switching models to capture the dynamic behavior of momentum return time series across regimes. We define pure momentum as the residuals from these models. Using US monthly equity data from 1962 to 2014, we find that standard macroeconomic variables, risk factors, and investor sentiment contribute to momentum returns. Residuals or pure momentum has large variation given the low goodness of fit of the regime switching models. Our tests find that pure momentum also partially explains equity returns and cannot be entirely explained by standard pricing factors.