Can Momentum Profits be Explained by Behavioral Factors?


            Momentum profits are the earnings resulting from regular stock market transactions with regard to the performances of the specific market stocks. Momentum strategy is thus the process of buying well-performing and selling poor performing equities to maximize the stock earnings (Jegadeesh & Titman, 1993).  There is both statistical and empirical evidence that momentum strategies have played a principal role in financial and economic success of the private investors as well as the entire economy (Hogan, et al., 2004). This study therefore seeks to establish whether momentum profits can be attributed to the behavioral factors and how investors can earn higher profits by using strategies unrelated to market dynamics.

Momentum profits do accrue from the arbitrageurs buying and selling decisions taken by investors on the basis of certain behavioral economic and financial behavioral factors. These behaviors create a particular inertia that leads to abnormal profits. The financial behaviors include extrapolation of market prospects, prejudiced self attribution, discriminatory information conditioning, conservatism in expectations updating and disposition effect (DeLong, et al., 1990).


            We will investigate whether market behaviors account for momentum profits in a multiple board situation. The study will be conducted from Stock Exchange of Singapore because momentum strategies are more visible here. Equity market is divided into two sets; the main board (SGX-MAINBOARD) and the secondary board (SGX-SESDAQ). The SGX-MAINBOARD lures well established companies through accruals in pre-tax profits of not less than $7.5 million in the past three years or a minimum market capitalization of $80 million during the IPO. The SGX-SESDAQ draws small and medium companies through sourcing funds from the stock market.

            Monthly portfolios will be created from March 1990 to December 2004, and then all eligible stocks will be graded autonomously according to their past returns. The stocks will be allocated to different deciles portfolios according to their performance in the past J months. J represents the number of months the stock has been trading in the market. The investments are held for K months, K being the number of months at an interval of 3 months, the portfolio is held. The earnings for K- months will be computed using the weighted average mean earnings of each stock in the portfolio. The winning and losing deciles will be analyzed for the next K months over a period of 14 years. The strategy will involve buying the winning and selling the losing portfolios for autonomous holding and creation periods.  

            Winners and losers will further be categorized into high (H), medium (M) and Low (L) volume portfolios. Basing on the mean monthly trading volume, the stocks in the deciles will be divided into the H, M and L sub-categories. Stock turnover ratios will be used to determine the classification of the trading volume. The strategy will seek to elongate the high volume portfolios and decrease the low volume portfolios (Grundy & Martin, 2001). H-L earnings will be calculated for every decile. Positive return will imply that high volume portfolios normally perform better than low volume portfolios and vice versa.


            This research established that occurrence of momentum drives profitability in equity investments. Both the main board and the secondary board exhibited strong momentum behavior.

The stocks listed under the secondary board exhibited stronger momentum effects. However, no direct relationship was established between equity earning and the trading volumes in medium holding periods. With the empirical results, we used the dollar neutral strategy to buy the winning portfolio and sell the extreme losers (Lee & Swaminathan, 2000) to compute mean dollar earning (R1-R10). We represent the extreme losers by R1 and extreme winners by R10 then we lengthen the winner portfolio and shorten the loser’s portfolio. The results therefore suggest the equities listed in the Singapore stock market do have existence of a strong persistent momentum effect.   

The study shows that on average, portfolios that buy past winners and disposes past losers earns high profits of about 14.1%. The duplication of the trading volumes revealed that transactions volume was directly responsible for predicting the future returns. It just provides information that is helpful in determining the trends of the returns in extensive holding periods. Trading volumes can be used to predict the consistency and turnaround in the trends of momentum in holding periods longer than one year. The size factor also explains the differences in the portfolio returns of the losers and winners.


            This paper explores several momentum trading behaviors in the Singapore stock market. We focused on the role of trading volumes and used diverse formations and portfolio holding periods to establish a relationship between momentum profits and behavioral factors in the stock exchange. We confirmed that returns of the smaller foreign and local companies are consistently higher than returns for larger firms. This research also invalidated the view that trading volume explicitly determines the future return on stock (Blume et al., 1994) but it acknowledged the fact that trading volumes provides important information on the degree of the extension of stock returns in longer investment periods. The limitations of this study was the inability to account for the costs associated with the transactions and limitations on short selling that was applicable through the study period.





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