Two Essays on Momentum Strategy and Its Sources of Abnormal Returns

146 Pages·2016·0.61 MB·English

by  Yu Zhang

UUnniivveerrssiittyy ooff TTeennnneesssseeee,, KKnnooxxvviillllee
TTRRAACCEE:: TTeennnneesssseeee RReesseeaarrcchh aanndd CCrreeaattiivvee
EExxcchhaannggee
Doctoral Dissertations Graduate School
12-2010
TTwwoo EEssssaayyss oonn MMoommeennttuumm SSttrraatteeggyy aanndd IIttss SSoouurrcceess ooff AAbbnnoorrmmaall
RReettuurrnnss
Yu Zhang
University of Tennessee - Knoxville, [email protected]
Follow this and additional works at: https://trace.tennessee.edu/utk_graddiss
Part of the Business Commons
RReeccoommmmeennddeedd CCiittaattiioonn
Zhang, Yu, "Two Essays on Momentum Strategy and Its Sources of Abnormal Returns. " PhD diss.,
University of Tennessee, 2010.
https://trace.tennessee.edu/utk_graddiss/931
This Dissertation is brought to you for free and open access by the Graduate School at TRACE: Tennessee
Research and Creative Exchange. It has been accepted for inclusion in Doctoral Dissertations by an authorized
administrator of TRACE: Tennessee Research and Creative Exchange. For more information, please contact
[email protected].
To the Graduate Council:
I am submitting herewith a dissertation written by Yu Zhang entitled "Two Essays on Momentum
Strategy and Its Sources of Abnormal Returns." I have examined the final electronic copy of this
dissertation for form and content and recommend that it be accepted in partial fulfillment of the
requirements for the degree of Doctor of Philosophy, with a major in Business Administration.
George C. Philippatos, Major Professor
We have read this dissertation and recommend its acceptance:
Phillip Daves, Larry Fauver, Jan Rosinski
Accepted for the Council:
Carolyn R. Hodges
Vice Provost and Dean of the Graduate School
(Original signatures are on file with official student records.)
To the Graduate Council:

I am submitting herewith a dissertation written by Yu Zhang entitled “Two Essays on
Momentum Strategy and Its Sources of Abnormal Returns.” I have examined the final electronic
copy of this dissertation for form and content and recommend that it be accepted in partial
fulfillment of the requirements for the degree of Doctor of Philosophy, with a major in Business
Administration.

George C. Philippatos, Major Professor

We have read this dissertation
and recommend its acceptance:

Phillip Daves

Larry Fauver

Jan Rosinski

Accepted for the Council:

Carolyn R. Hodges
Vice Provost and Dean of the Graduate School

(Original signatures are on file with official student records.)
Two Essays on Momentum Strategy and Its Sources of
Abnormal Returns

A Dissertation Presented for the
Doctor of Philosophy
Degree
The University of Tennessee, Knoxville

Yu Zhang
December 2010
Copyright © 2010 by Yu Zhang.
All rights reserved.

ii
ACKNOWLEDGEMENTS

Thanks to Dr. George C. Philippatos. This thesis would not be possible without
you. Special thanks to Dr. Phillip Daves and Dr. Larry Fauver for your great support not
only in my writing of dissertation but also in my study in the finance department. Thanks
to Dr. Jan Rosinski for willing to be a member in my committee. Great appreciation to
the following professors who are not in my committee but have helped me tremendously
in my completion of this dissertation: Dr. Christian Vossler and Dr. Mike Newman.
Finally, thanks to Dr. Jim Wansley and the finance department for providing financial
support and precious opportunities to me throughout these years at University of
Tennessee.

iii
ABSTRACT

This dissertation studies the sources of the momentum abnormal returns. The first
essay attempts to find the relative role of cross-sectional and time-series variances in
generating returns from the momentum strategy. By decomposing the returns from the
momentum strategy both theoretically and empirically, the first essay finds that own-
stock autocovariance is an important source in generating momentum returns. More
interestingly, the own-stock autocovariance comes primarily from the loser portfolio.
This finding provides another explanation to the recent finding that the loser portfolio is
the driving force of the momentum abnormal returns.
Based on the above discovery from the first essay, the second essay attempts to
find out the underlying reason for the important asymmetric own-stock autocovaraince
from the loser portfolio. We find that this return predictability comes from the short-
selling constraints and risks. Stocks with more severe short-selling constraints prevent
pessimistic information from being released into the stock prices more quickly; and thus
causes those stocks to be overpriced and auto-correlated in their returns.

iv
TABLE OF CONTENTS

Table Page

CHAPTER I 1 
INTRODUCTION 1 
CHAPTER II 3 
UNDERSTANDING THE SOURCES OF ABNORMAL RETURNS FROM THE
MOMENTUM STRATEGY 3 
Abstract 3 
I. Introduction 4 
1.1. Background 4 
1.2. Motivation 6 
II. Literature Review 9 
2.1. Stock Trading Strategies 9 
2.2. Literature Review 11 
III. Decomposition of Momentum Returns 22 
3.1. Theoretical Model 22 
3.2. Circumstance in Generating Positive Momentum Returns 29 
IV. Empirical Results 30 
4.1. An Empirical Appraisal of Momentum Returns 30 
V. Conclusions 37 
LIST OF REFERENCES 39 
APPENDIX 49 
CHAPTER III 53 
SHORT-SELLING CONSTRAINTS AND MOMENTUM ABNORMAL RETURNS 53 
Abstract 53 
I. Introduction 54 
II. Short-Selling Risks 62 
2.1. Short-Selling Mechanics 62 
2.2. Short-Selling Risks 63 
2.3. SEC Pilot Program 65 
III. Literature Review 65 
3.1. Market Frictions Explanation 66 
3.2. Proxies for Short-selling Constraints 69 
3.3. Other Factors Influencing Short-Selling Risk 73 
IV. Theory and Hypotheses 77 
V. Data and Methodology 80 
5.1. Summary Statistics 83 
5.2. Pooled Interval Regression and the True Demand for Shorting 85 
VI. Estimated Realizable Shorting Demand and Short-selling Constraints 88 
6.1. Short Interest Ratio and Institutional Ownership 88 
6.2. Estimated Interval Regression Model 90 
6.3. Short-selling Constraints 95 
v
VII. Short-selling Constraints and Momentum Abnormal Returns 96 
7.1. Portfolio Sorts on Short-selling Constraints 96 
7.2. Momentum Strategy and Short-selling Constraints 100 
7.3. Risk Adjustments 101 
7.4. NASDAQ Effect 106 
7.5. Reg. SHO Pilot Program 108 
VIII. Conclusions 112 
LIST OF REFERENCES 114 
CHAPTER IV 134 
CONCLUSIONS 134 
VITA 135 

vi
LIST OF TABLES

Table Page

Table 1. Return Decomposition with All Stocks in the U.S. Market ................................ 43 
Table 2. Return Decomposition with NYSE & AMEX Stocks Only ............................... 46 
Table 3. Return Decomposition with Change of Weights ................................................ 47 
Table 4. Return Decomposition following Lo & MacKinlay (1990) ............................... 48 
Table 5. Summary Statistics ........................................................................................... 121 
Table 6. Summary Statistics of SIR and IOS .................................................................. 122 
Table 7. Pooled Interval Regression ............................................................................... 123 
Table 8. Double Sorting .................................................................................................. 124 
Table 9. Double Sorting of SC and RET ........................................................................ 126 
Table 10. Factor Models ................................................................................................. 127 
Table 11. Short-squeeze Risk & Factor Models ............................................................. 129 
Table 12. Momentum Returns with and without NASDAQ Stocks ............................... 131 
Table 13. NASDAQ Effect ............................................................................................. 132 
Table 14. Summary Statistics of Pilot and Control Sample before the Pilot Program ... 132 
Table 15. Pilot Program Effect ....................................................................................... 133 

vii