patterns in momentum profits that will be robust to transactions costs. It will
also be demonstrated below that the pattern of momentum profits is split
evenly between winning and loosing stocks, that is, the strategy of buying
past winners still outperforms the index and mirrors the time pattern of mean
returns on the momentum portfolio.
4. RESULTS
Before presenting the results of the current exercise it is worth summarizing
the main results reported by HP. The most striking result is the statistically
significant evidence found for the existence of short- to medium-term
momentum in Australian stocks. Specifically, HP found that momentum
profits for the yearly holding period post formation were statistically
significant and ranged from 4.79% to 7.13% for portfolios formed from the
largest 200 stocks. HP also evaluated a number of suggested explanations for
the momentum and found them all to be unable to explain the magnitude of
the returns. It was also found that following a contrarian investment strategy
did not yield statistically significant abnormal returns over the investment
horizons considered. For the record, Figure 1 reproduces the original results in
HP with the proviso that the missing values are treated differently and the
universe of stocks has changed.
Note that in the current research the significance of momentum profits in each
period is not tested for. This is motivated by the recognition that the level of
momentum profits will be influenced by the particular assumptions adopted to
deal with the issues of missing observations, stock exits and transactions costs
(such as short-selling restrictions). On the other hand, the time profile of
holding period returns following portfolio formation appears to be a very
robust feature of the data. A more satisfactory approach therefore would be to
construct a test of the time pattern of momentum profits. This would require
the formulation of a statistical model that can explain the observed pattern of
profits over different horizons and is beyond the scope of this short update.