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FRM Part II · FRM Exam Part II · Factors

A momentum strategy ranks stocks on their cumulative returns over the past 12 months, skipping the most recent month, and goes long the top decile and short the bottom decile. Why is the most recent month commonly skipped?

The latest month is skipped to avoid short-term reversal. Stock returns over about one month tend to reverse, whereas returns over 3 to 12 months tend to continue. Including the last month would mix the opposing reversal effect into the momentum signal and weaken it.

  1. ATo avoid short-term reversal effects that contaminate the momentum signalCorrect
  2. BTo remove the size effect from the ranking
  3. CTo ensure the portfolio has zero market beta
  4. DTo reduce exposure to the value factor

Explanation

At one-month horizons returns tend to reverse, which is opposite to the intermediate-horizon continuation that defines momentum. Skipping the latest month keeps the short-term reversal from diluting the signal. Skipping does not target beta, size or value exposure.

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