Working Paper

Cross-Sectional Factor Dynamics and Momentum Returns

Abstract: This paper proposes and implements an inter-temporal model wherein aggregate consumption and asset-specific dividend growths jointly move with two mean-reverting state variables. Consumption beta varies through time and cross sectionally due to variation in half-lives and stationary volatilities of the dividend signals. Winner (Loser) stocks exhibit high (low) half-lives and stationary volatilities, and thus exhibit high (low) consumption beta commanding high (low) risk-premium. The model also rationalizes the \"momentum crashes\" phenomenon discussed in Daniel and Moskowitz (2014). High half-lives of dividend signals in Winners keep their consumption betas low long after recovering from a prolonged economic downturn, while low half-lives in Losers make their consumption betas grow rather quickly. Thus, coming out of a recession, the long Winner/short Loser strategy reduces in consumption beta and, hence, risk-premia.

Keywords: Momentum; Cross-Sectional Dynamics; Long-Run Risk; Bayesian Filtering;

JEL Classification: C32; G12;

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Bibliographic Information

Provider: Federal Reserve Bank of Boston

Part of Series: Supervisory Research and Analysis Working Papers

Publication Date: 2015-10-22

Number: RPA 15-2

Pages: 59 pages