Can diversification degree amplify momentum and contrarian anomalies?

Houda Ben Mhenni Haj Youssef, Lassad El Moubarki and Olfa Benouda Sioud

Review of Accounting and Finance, 2010, vol. 9, issue 1, 50-64

Abstract: Purpose - The purpose of this paper is to analyse the impact of industrial diversification on the profitability of contrarian and momentum strategies. Design/methodology/approach - Using monthly returns, the weighted relative strength strategy (WRSS) is applied to 249 American listed stocks from January 1994 to April 2004. To study the impact of the 2000 crash on the results, the WRSS strategy during the 01/1994‐03/2000 and 04/2000‐04/2004 sub‐periods was implemented. Then, firms are classified, according to the intensity of their industrial diversification by Ward's method of hierarchical cluster analysis, into two sub‐samples: the diversified and non‐diversified samples. The WRSS strategy was re‐implemented on these sub‐samples. Finally, the Bootstrap without replacement is used to explore the risk‐based explanation of the trading strategies' profitability. Findings - Results show that the momentum strategy seems to be no more profitable in the recent years. In fact, while momentum strategies earn large positive and significant returns before the 2000 crash, these returns are negative after the crash. Moreover, before the crash, the momentum effect was more pronounced for the non‐diversified sample. After the crash, a contrarian effect more important for this sample was identified. Finally, the Bootstrap without replacement results do not support the risk‐based explanation. Research limitations/implications - Future research may study the impact of diversification on investor psychology. Practical implications - Diversified firms are efficiently valued. However, specialized firms are not correctly valued. Originality/value - This is the first study that shows that contrarian or momentum portfolios formed by industrial diversification did not yield significant return.

Keywords: Corporate strategy; Diversification; Momentum; Return on investment; Risk management (search for similar items in EconPapers)
Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:eme:rafpps:v:9:y:2010:i:1:p:50-64

DOI: 10.1108/14757701011019817

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