Momentum Investing: The World’s Longest Backtest: 1801-2012

Christopher Geczy, University of Pennsylvania – The Wharton School, Finance Department and Mikhail Samonov are out with a new report titled 212 Years of Price Momentum (The World’s Longest Backtest: 1801-2012):

We assemble a dataset of U.S. security prices between 1801 and 1926, and create an outof-sample test of the price momentum strategy, discovered in the post-1927 data. The pre-1927 momentum profits remain positive and statistically significant. Additional time series data strengthens the evidence that momentum is dynamically exposed to market beta, conditional on the sign and duration of the tailing market state. In the beginning of each market state, momentum’s beta is opposite from the new market direction, generating a negative contribution to momentum profits around market turning points. A dynamically hedged momentum strategy significantly outperforms the un-hedged strategy.

Momentum Investing: The World's Longest Backtest: 1801-2012

The first two U.S. stocks traded hands in 1792 in New York. Over the following decades, the security market developed rapidly. By the end of 1810, 72 traded securities existed, and by the end of 1830s the number was over 300. To our knowledge, all current academic studies of U.S. security-level data begin in 1926, the year the CRSP database began. The U.S. market had been active for 133 years before that time, providing an opportunity to test stock-level studies in earlier history. The 19th and early 20th centuries are filled with expansions, recessions, wars, panics, manias, and crashes, all providing a rich out-of-sample history. Limiting studies to the post-1925 period introduces a strong selection bias and does not capture the full distribution of possible outcomes.

The potential Outcomes Of Momentum Profits

For example, in the case of price momentum, before 2009, only following the Great Depression did the strategy have a decade-long negative compounded return. Such occurrence was concluded to be an outlier and the remaining part of the distribution taken as normal. Since 2009, second worst financial collapse, momentum has experienced another decade long underperformance creating a large ripple in investment portfolios that use this strategy. The repeated underperformance raised practical questions about the outlier conclusion and what the actual distribution of momentum profits is. By extending the momentum data back to 1801, we create a more complete picture of the potential outcomes of momentum profits, discovering 7 additional negative decade long periods prior to 1925.

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