Profitability of Risk-Managed Industry Momentum in the U.S. Stock Market

Abstract

This Master’s thesis examines whether risk-managing industry Momentum via the methodology of Barroso and Santa Clara (2015) produces a more profitable strategy than industry Momentum by itself. Industry Momentum is also tested in a previously unexamined period to see whether or not the strategy still produces abnormal returns.

By using data from the U.S. stock market between 1928 – 2015, multivariate regressions that utilize the Fama-French Three and Five Factor Model are run in an attempt to explain returns to industry Momentum and risk-managed industry Momentum. Additionally, robustness tests are conducted in the same vein in subsample time-periods.

The results indicate that risk-managed industry Momentum produces statistically significant abnormal returns in all time-periods tested. Industry Momentum is also still found to be prevalent in the U.S. stock market in producing abnormal returns. Risk-managed industry Momentum is more profitable as well, compared to industry Momentum by measuring Sharpe ratios and abnormal returns for both strategies.

These findings suggest that risk-managing Momentum with the Barroso and Santa Clara methodology works not only for individual stocks, but industries as well. Risk-managing industry Momentum produces significant abnormal returns and a high Sharpe ratio while eliminating negative skewness in return distribution. This arguably eliminates Momentum crashes from industry Momentum completely.