BFS 2002

Contributed Talk

Firm-Level Momentum: Theory and Evidence

Jacob Sagi, Mark Seasholes

This paper argues that the profitability of momentum strategies can be tied to the dynamics of firm-specific factors. We frame our argument within a model and test its predictions. We show that momentum can exist when the log market value of equity is increasing and convex (or decreasing and concave) with respect to the log price of the commodity produced by the firm. The addition of growth options will increase the convexity, and thus the profits from a momentum strategy. Costs, on the other hand, decrease convexity and lower momentum. The first contribution of this paper is that our model produces testable hypotheses that are largely borne out in the data. The most convincing evidence in favor of our theory is that, as predicted by the model, a momentum strategy implemented in a subsample of low cost-leverage or high market-to-book firms produces significantly greater returns than a momentum strategy implemented in a subsample of high cost-leverage or low market-to-book firms. The second contribution of this paper is that it ties the microeconomics of the firm to asset pricing. Although momentum might arise under different scenarios, we argue and present evidence that it can be traced directly to firm-specific factors.