A Functional Modeling Approach to Stock Market Momentum

Abstract

This paper proposes a novel dynamic function to capture the phenomenon of momentum in financial markets. It occurs when high returns subsequently follow a security’s past high returns, and subsequent low returns follow its past low returns. By exploring an analogy to the momentum definition from physics, we model financial momentum as the product of a stock’s return and its number of shares outstanding with considerations of the difference between its market price and intrinsic price. In contrast to traditional proxies, where the momentum is described as the rate of acceleration of a security’s price or volume and is calculated based on past 12-month returns or the associated accumulation in returns, the dynamics of our model exhibit advantageous trading characteristics for common momentum-based strategies.