Is there any theory which is able to unify and/or falsify existing explanations on the causes of asset price/return momentum? The prevailing theory is that behavioral and cognitive biases lead to momentum, but I strongly suspect that momentum has multiple causes and this conflation between variables explains why market theoreticians and practitioners have such a difficult time explaining it. For example, I find it highly plausible that the causes of observed momentum in individual securities differ greatly from that which is observed at the industry/sector and asset class levels.

I am aware of the definition of momentum, the statistical arguments for its existence, as well as the numerous ways in which momentum can be measured. I am also aware of some of that it has been observed for a number of asset classes including equities, sectors of equities, commodities, and others. Furthermore, I am aware of some of the theoretical underpinnings for momentum. However, I am not aware of any unifying theory which is able either subsume and/or falsify existing arguments.

Some of these theoretical arguments are summarized below:

  1. Informational asymmetry (e.g., "price leads fundamentals").
  2. Limits to market efficiency (e.g., slower diffusion of information than expected under EMH; institutional constraints; liquidity constraints; etc...)
  3. Various behavioral arguments (e.g., cognitive dissonance; sentiment; greed/envy; bandwagon effect; "under(over)-reaction to good (bad) news")
  4. Style/factor/asset-class rotation (e.g., reaction to the confluence of economic/business/market cycles)
  5. Capital gains deferral (i.e., tax loss selling)

While existing narratives all sound plausible, they are neither broadly encompassing nor falsifiable. I.e., none are mutually exclusive and/or inclusive. While I am willing to accept that momentum is simply the confluent result of several distinct factors and interactions between factors (in which case there would be no broader explanation), I also believe that there should be a way to better articulate observed phenomena.

I ask because I am trying to figure out a practical solution to a factor-based returns attribution model. Specifically, I am trying to determine whether to group momentum under an existing classification, make it its own classification (i.e., it subsumes multiple classifications), or include different aspects of momentum under multiple classifications (e.g., security price momentum under asymmetry; sector momentum under sentiment/rotation; etc..).

As a bonus question, how does any of this articulate with observed mean reversion?

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    $\begingroup$ I'd put momentum (and related effects) as its own top-level entry in a taxonomy. Momentum is a pervasive empirical phenomenon, and while much has been written (theory & empirics) on possible mechanisms, it's an extremely open question. We don't know why. (And there's even debate as to what it is.) $\endgroup$ Feb 7, 2018 at 16:12
  • $\begingroup$ @MatthewGunn. It's just fascinating to me there is so much emphasis on the phenomenon and yet so little is actually known about it. It just seems like someone ought to develop a framework which is falsifiable. I.e., the focus should shift to "what doesn't cause momentum?". $\endgroup$ Feb 7, 2018 at 16:24

1 Answer 1


Vayanos & Woolley have proposed a unified theory of momentum & reversal due to institutional fund flows, but their analysis appears to be limited to stocks. To quote:

Our explanation of momentum and reversal is as follows. Suppose that a negative shock hits the fundamental value of some assets. Investment funds holding these assets realize low returns, triggering outflows by investors who update negatively about the efficiency of the managers running these funds. As a consequence of the outflows, funds sell assets they own, and this depresses further the prices of the assets hit by the original shock. Momentum arises if the outflows are gradual, and if they trigger a gradual price decline and a drop in expected returns. Reversal arises because outflows push prices below fundamental values, and so expected returns eventually rise. Gradual outflows can be the consequence of investor inertia or institutional constraints, and we simply assume them. We explain, however, why gradual outflows can trigger a gradual decline in rational prices and a drop in expected returns. This result, key to momentum, is surprising.

I am not aware of anything more all-encompassing than this, perhaps others have better references?

  • $\begingroup$ Thank you for the response. Flow of funds definitely seems like a good candidate. "Gradual outflows can be the consequence of investor inertia or institutional constraints, and we simply assume them" implies that both sentiment and limits to market efficiency are underlying factors. It also does not rule out the possibility that fundamental shocks can occur to an entire segment or asset class which could explain the rotation effect. lmplied throughout is that momentum and reversal are in response to fundamental shocks, which seems to preclude the possibility that momentum leads fundamentals. $\endgroup$ Feb 5, 2018 at 17:24

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