Dynamics of momentum effects and long-run risk model

This thesis examines the dynamics of momentum effects in the two-regime switching model and momentum effects in the long-run risk model. A two-regime switching model was built to analyse the switching that can be controlled by the level of market risk between the momentum effect and return reversal. Further, the study examined the relationship between the three independent variables of domestic market risk, returns in the ranking period, and foreign financial market risk (i.e., US market risk and UK market risk). It found that the momentum return in both stock markets has a significant positive effect on foreign market risk, and a negative effect on return in the ranking period and domestic market risk in the momentum regime. However, the results for the US market were insignificant in the reversal regime when compared with those for the UK market. Further, a cross-sectional long-run risk model was developed at the level of individual security. The assumption of fluctuation economic volatility was extended to allow for the effect of economic uncertainty on the aggregate consumption growth and dividend growth of individual security. Theoretically, the model provides a more significant explanation for momentum returns. In conclusion, the model matches the relative portfolios’ returns, dividend growth, and valuation ratio at the portfolio level via its simulation.