Idiosyncratic momentum on the JSE

ABSTRACT

Idiosyncratic momentum, like price momentum, is a trading strategy that considers a share’s recent relative performance over the short to medium term. Idiosyncratic momentum differs from price momentum as it uses residual returns post-orthogonalization on a single or multi-factor asset pricing model. Recent literature has shown that idiosyncratic momentum consistently outperforms price momentum on a risk-adjusted basis, is less prone to long-term reversal and has been proven successful in regions that have previously shown to have a non-existent price momentum premium. Previous studies attribute the success of idiosyncratic momentum to ‘underreaction’, whereby market participants tend to underreact to idiosyncratic momentum signals. We attempt to determine whether idiosyncratic momentum displays the same positive attributes found in international literature. We find that idiosyncratic momentum is superior to price momentum in terms of performance and explanatory power. The results reject a risk-based explanation of idiosyncratic momentum as minimising factor exposure (by using residual returns) improves performance. However, we find limited evidence of underreaction driving idiosyncratic momentum. Notwithstanding the lack of an a priori exposition of idiosyncratic momentum’s existence, the results provide concrete evidence of idiosyncratic momentum’s superiority over price momentum on the JSE, a finding important for both practitioners and academics alike.

KEYWORDS:

• Momentum
• idiosyncratic momentum
• price momentum
• underreaction
• long-term reversal

Notes

1 For the purpose of consistency with prior literature, we tested whether scaling idiosyncratic momentum by residual volatility impacted performance. Consistent with the findings of Blitz et al. (2017), the impact of scaling idiosyncratic momentum scores by residual volatility has virtually no impact on nominal or risk-adjusted returns.