FRM Part II · FRM Exam Part II · Factor Theory
An analyst builds a momentum signal for a universe of stocks. Which construction is most consistent with the conventional momentum factor used in academic and practitioner research?
The conventional momentum factor ranks stocks on the past 12-month return excluding the latest month, buying winners and shorting losers. Skipping the most recent month avoids the short-term reversal effect, which would contaminate the signal.
- ARank stocks on the cumulative return over the prior 12 months excluding the most recent month, going long winners and short losersCorrect
- BRank stocks on the cumulative return over the most recent month only, going long winners and short losers
- CRank stocks on the prior 12-month return including the latest month, going long losers and short winners
- DRank stocks on book-to-market ratio over the prior 12 months, going long high ratios and short low ratios
Explanation
Conventional momentum uses past 12-month returns skipping the most recent month, to avoid the short-term reversal effect, and buys winners while shorting losers. Using only the last month captures reversal, not momentum. Going long losers reverses the sign. Book-to-market is a value signal.
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