We study dynamic portfolio choice in a calibrated equilibrium model where value and momentum anomalies arise because capital slowly moves from under- to over-performing market segments. Over short horizons, momentum’s Sharpe ratio exceeds value’s, the value-momentum correlation is negative, and the conditional value-momentum correlation positively predicts Sharpe ratios of value and momentum. In contrast, over long horizons, value’s Sharpe ratio can exceed momentum’s, the value-momentum correlation turns positive, and the value spread becomes a better predictor of Sharpe ratios. Momentum’s optimal portfolio weight relative to value’s declines significantly as horizon increases. We provide novel empirical evidence supporting our model’s predictions.
Financial Markets Group Discussion Papers DP 864
Paul Woolley Centre Discussion Papers No 89