Conclusion:
The combination of mean reversion and momentum factors into one strategy
produces significant excess returns. This model outperforms the individual pure
momentum and mean-reversion strategies respectively.
BACKGROUND
•
The contrarian strategy/ Mean reversion:
o
sorts firms by their past returns
o
longs firms that performed the worst in the past and
o
sells firms that performed the best
•
So does a momentum strategy:
o
sorts firms by their past returns
o
shorts firms that performed worst in past and
o
longs firms that performed the best in the past.
•
Fam
a and French’s parametric approach momentum and mean reversion
strategies performed better than the strategies individually.
•
Variance of momentum and mean reversion components reveals that both
factors are of similar importance when deciding combination strategy
portfolio choices
•
The correlation between momentum and mean reversion effects is quite
sizeable and negative correlation therefor to be discussed jointly.

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P a g e
RESULTS
The pure momentum strategy is equivalent to accounting only for momentum in the
baseline model. All excess returns are found to be positive and significant.
The pure mean reversion is when momentum value is set to zero. The returns of this
strategy come back positive and significant.
The corrections due to factor sensitivities and exchange rate risk are found to have
little effect on the returns. Therefore factor sensitivities do not provide obvious
explanation for the strategy returns.
Transaction costs are significant as they eliminate just under half of the excess
returns.