One anomaly to explain them all

Abstract

We argue that conditional on the existence of momentum, many other asset pricing anomalies are not particularly anomalous. First, empirically, we show that the return to the momentum strategy (i.e. the momentum premium) is higher among some stocks than others, and that the momentum premium of a portfolio negatively predicts the portfolio's unconditional average return. Second, we rationalize this in a standard model to which we add momentum; the intuition is that speculators prefer to buy assets with higher momentum premium and bid up the prices of those assets. Third, we find that for many asset pricing anomalies, the momentum premium of the long leg is much lower than the momentum premium of the short leg. Thus, according to our model, the long leg should earn higher unconditional average returns in equilibrium, which explains the anomaly. Once accounting for this effect, the average Fama French 3 factor alpha across 36 prominent anomalies falls by up to 47%. Finally, we show that although the CAPM beta is negatively related to the average unconditional return of a large set of portfolios, it is strongly positively related to the portfolios' momentum premia, which helps explain the apparent empirical failure of the CAPM.