Abstract:
This paper suggests a parsimonious two-factor model to explain momentum in
stock price containing the market risk factor and a factor related to risk caused by
unexpected earnings surprises. The risk factor related to unexpected earnings surprises is
unconditional on information uncertainty and is constructed from risk factors conditional
on the degree of information uncertainty. The standard deviation of analysts’ earnings
forecasts is used as a proxy for the degree of earnings information uncertainty. This twofactor
model fairly well fairly well explains momentum in time-series tests and crosssectional
tests. Based on the empirical results, momentum is closely related with earnings
surprises and may be compensation for bearing risk caused by earnings surprises. The
reason that previous studies failed to show for the cross-sectional difference in expected
returns to be a primary cause of momentum may be due to the fact that misspecified
factor models were used.
