Question

4 According to the momentum effect, winner stocks on average generate high returns than loser stocks...

4 According to the momentum effect, winner stocks on average generate high returns than loser stocks on average. Historically, winner stocks and loser stocks have similar market beta. This means the winner-minus-loser return (2)

A. Cannot be fully explained by the CAPM model

B. Generate zero alpha in the CAPM model

C. Generate negative alpha in the CAPM model

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Answer #1

correct answer is: A. Cannot be fully explained by the CAPM model

Explaination:

  1. Average returns on portfolios are not fully explained by asset pricing models such CAPM
  2. Stock returns generally exhibit a pattern of short term momentum as well as reversal in long term returns when short term momentum effect is controlled. a study by Sanjay Sehgal and Sakshi Jain in 2011 conclude that momentum profits are not explained by one factor CAPM
  3. Momentum profits are associated with different sources such as company characteristics and hence momentum profits are left unexplained by CAPM
  4. CAPM does not capture returns on any of the portfolios excepting loser portfolio as alpha (intercept) of winner portfolio is not indistinguishable from zero
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