Charles A. Dice Center for Research in Financial Economics Investment-Based Momentum Profits

We offer an investment-based explanation of momentum. The neoclassical theory of investment implies that expected stock returns are related to expected investment returns, defined as the next-period marginal benefits of investment divided by the current-period marginal costs of investment. Empirically, winners have higher expected growth of investment-to-capital and higher expected marginal product of capital and consequently higher expected stock returns than losers. The investment-based expected return model captures well the moment profits across a wide array of momentum portfolios. However, the individual alphas for several testing portfolios are large. All in all, we conclude that momentum is consistent with the value maximization of firms. Finance Department, School of Business and Management, Hong Kong University of Science and Technology, Kowloon, Hong Kong. Tel: (852) 2358-7661, fax: (852) 2358-1749, and e-mail: [email protected]. Department of Finance, Fisher College of Business, Ohio State University, 760A Fisher Hall, 2100 Neil Avenue, Columbus OH 43210; and NBER. Tel: (614) 292-8644, fax: (614) 292-7062, and e-mail: [email protected]. We thank Jennifer Huang, Frank Yu, and other seminar participants at Cheung Kong Graduate School of Business and China Europe International Business School for helpful comments. The portfolio level data and Matlab programs used in our GMM estimation and tests are available from the authors upon request. All remaining errors are our own.