AQR White Paper
Momentum is a well-established empirical fact whose premium is evident in over 83 years of U.S. data, in 20 years of out-of-sample evidence from its original discovery, in 40 other countries, and in more than a dozen other asset classes.
The presence and robustness of momentum are remarkably stable and has, along with size and value premia, become the preeminent empirical regularities studied by academics and practitioners. And, like size and value, there is much debate and little consensus regarding the explanation driving this premium, though there are some compelling theories.
In this paper, we summarize briefly two broad explanations for momentum: one based on the argument that the momentum premium is compensation for risk and another based on investor behavior, such as investor underreaction and delayed overreaction to news. While the jury is still out on which explanation better fits the data, we emphasize that similar uncertainty is behind explanations of the size and value premia.
Much like momentum, stories for the size and value premium range from risk-based to behavioral and there is a healthy debate over which of these theories is most consistent with the facts. These debates are likely to continue, but as we discuss here there are many viable candidate theories for their existence — and the truth behind the source of these premia probably contains elements from several explanations.
From an investment perspective, whether there is a rational risk-based or behavioral story is of second order importance. Why? Because both explanations — risk and behavioral — provide a reason for the premium to persist.