The Momentum Enigma: Challenging Market Efficiency
📊Alfa Hedge Portfolio Update 23-10-18
The Momentum Enigma: Challenging Market Efficiency
The age-old belief in market efficiency is getting a run for its money, and the game-changer is called "momentum."
Over three decades, this mystery continues to baffle and intrigue scholars and investors alike.
Understanding the Momentum Phenomenon
The phenomenon of momentum can be succinctly described as the tendency for past winners in the stock market to continue their winning streak, while the underperformers tend to lag.
This observation, at its core, presents a direct contradiction to the Efficient Market Hypothesis (EMH), which posits that market prices always accurately reflect all available information.
Risk-Based Explanation: One school of thought suggests that momentum is merely a reflection of an inherent risk factor. In this view, recent high performance indicates increased risk, prompting higher returns as a form of compensation.
Behavioral Explanation: Another perspective attributes momentum to behavioral biases inherent in investors. This theory posits that investors might exhibit patterns of overreaction or underreaction to new information, leading to price discrepancies.
Implications for Traditional Financial Models
The implications of the momentum phenomenon extend far beyond academic discourse.
Its existence raises profound questions about the veracity of established financial models, such as the Capital Asset Pricing Model (CAPM).
As a result, the academic and professional communities are now turning their attention to multi-factor models, which seek to integrate momentum as one of the key determinants of asset prices.
Bottom Line
The study of momentum is reshaping our understanding of financial markets.
Its continued presence forces us to reevaluate foundational principles and adapt to a landscape where market efficiency may not always hold true.
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