The Interaction of Value and Momentum
Clifford S. Asness
Value and momentum strategies both have demonstrated power to predict the crosssection of stock returns, but are these strategies related? Measures of momentum
and value are negatively correlated across stocks, yet each is positively related to the
cross-section of average stock returns. We examine whether the marginal power of
value or momentum differs depending upon the level of the other variable. Value
strategies work, in general, but are strongest among low-momentum (loser) stocks
and weakest among high-momentum (winner) stocks. The momentum strategy
works, in general, but is particularly strong among low-value ...view middle of the document...
In particular, they are most effective when the definition of momentum excludes returns over the
most recent month.2 The evidence that momentum
strategies work is convincing. As with the value
strategies, however, the explanation of why they
work is largely incomplete.
For this study, we examined whether value
and momentum strategies are independent or
related, asking how well value strategies work
Clifford S. Asness is a managing director at Goldman,
Sachs & Company.
Financial Analysts Journal • March/April 1997
among stocks that have exhibited both strong
momentum (winners) and weak momentum (losers). Similarly, we looked at momentum strategies
among only high-value (cheap) or only low-value
(expensive) stocks. We found that value works, in
general, but that it is particularly strong among
loser stocks and quite weak among winner stocks.
Momentum also works, in general, but is particularly strong among expensive stocks.
Our ﬁndings do not help distinguish between
rational and irrational asset pricing. Consider our
observation that value does not work for winner
stocks. Assume ﬁrst that value strategies work
because variables such as book-to-market ratio are
related to an underlying priced distress factor (the
rational pricing case). In this case, BV/MV is certainly not a true risk-factor loading but simply a
noisy proxy for such a loading. Conditional on a
ﬁrm having a high BV/MV, it is likely to be distressed and thus load strongly on the risk factor
related to distress. Also possible, however, is that
conditional on a ﬁrm jointly having a high BV/MV
and high recent return, it is unlikely to be distressed. In other words, strong recent returns indicate that distress is unlikely no matter what the BV/
MV. Because this ﬁrm is not distressed, it does not
load strongly on the distress factor and has no
corresponding expected return premium over winners with lower BV/MVs. Put differently, winners,
no matter what their BV/MVs, are not generally
distressed. Thus, our results can be consistent with
BV/MV being a noisy proxy for a distress factor in
a rational asset-pricing model.
Next, assume that value strategies work not
because of rational pricing of risk but because
investors are “uncomfortable” with holding the
assets found cheap by value measures (one version
of the irrational case). Investors willing to hold
these uncomfortable assets receive an expected
return premium. Also possible is that no matter
what an asset’s BV/MV, investors are never
uncomfortable with recent winners, and hence,
owning these stocks does not earn a return premium. Because our results can ﬁt both explanations, they do not distinguish between the rational
and irrational stories for the success of value and
momentum strategies. Our results, however, do
add to the set of stylized facts that the ultimate
explanation must cover.
In general, value and momentum are related,
and the cross-section of...