The Power of Past Stock Returns to Explain Future Stock Returns
January 1, 1995
Topics - Equities Factor/Style Investing Momentum
AQR Working Paper
Researchers have long argued over whether strategies based on past stock returns have the power to explain future stock returns. Some have discovered past-return-based strategies that appear powerful for predicting future stock returns. The most important are short-term contrarian strategies, near-term momentum strategies, and long-term contrarian strategies. This paper makes several important contributions to this ongoing work.
Other research has commonly focused on these strategies one at a time. We test each past return based strategy in a common framework. We define a new three-variable specification for past returns so as to clearly distinguish the strategies discussed above.
While this paper finds no convincing evidence that either short-run or long-run contrarian strategies represent important factors for explaining the cross-section of stock returns, we do find that the properly specified one-year momentum strategy has explanatory power for stock returns when used alone, when tested against size and book-to-market, and when subjected to exhaustive robustness checks.
We extend our common framework to test past return based strategies against firm size and book-to-market, variables found by other authors to predict stock returns and to subsume the power of many other measures. We test whether other effects may be driving our results (e.g., risk changes, liquidity, bid-ask effects), and we uncover a new and powerful conditional relation between liquidity and future returns (i.e., that this relation changes based on short-term performance). Finally, we test whether our strong results are period specific.
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This material is not research and should not be treated as research. This paper does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of AQR. The views expressed reflect the current views as of the date hereof and neither the author nor AQR undertakes to advise you of any changes in the views expressed herein.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither AQR nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such.
The information in this paper may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.