The Power of Past Stock Returns to Explain Future Stock Returns

Topics - Equities Factor/Style Investing Momentum

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The Power of Past Stock Returns to Explain Future Stock Returns

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.

This document is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein.

This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and AQR Capital Management, LLC (“AQR”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. This document is not to be reproduced or redistributed to any other person. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision. Past performance is not a guarantee of future performance. 

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. Diversification does not eliminate the risk of experiencing investment losses.

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.