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Science or scientism? On the momentum illusion

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  • Klaus Grobys

    (University of Vaasa
    University of Vaasa)

Abstract

This study explores the risk of the traditional momentum strategy in terms of its realized variance using various data frequencies. It is shown that momentum risk is infinite regardless of the data frequency, implying that (a) t-statistics for this strategy do not exist, (b) correlation-based metrics such as Sharpe ratios do not exist either, and (c) the momentum premium is not observable in reality. It is further shown that the time-honored lognormal distribution is unable to accurately model extreme events observed at various variance data frequencies. Finally, it is shown that the well-known effect of time aggregation does not work for this investment vehicle. Hence, the study is forced to conclude that momentum stories have no valid foundation for their claims.

Suggested Citation

  • Klaus Grobys, 2024. "Science or scientism? On the momentum illusion," Annals of Finance, Springer, vol. 20(4), pages 479-519, December.
    • Handle: RePEc:kap:annfin:v:20:y:2024:i:4:d:10.1007_s10436-024-00446-5
    DOI: 10.1007/s10436-024-00446-5
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    More about this item

    Keywords

    Asset pricing; Financial risk; Momentum; Power laws; Realized variance; Risk; Time aggregation;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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