MARKET STATES AND THE PROFITABILITY OF MOMENTUM STRATEGIES: EVIDENCE FROM THE TAIWAN STOCK EXCHANGE

This paper examines the impact of market states on the profitability of momentum strategies using weekly data from the Taiwan Stock exchange over the 10-year period 1997-2006. Market states refer to the states of market such as up or down markets. In this paper, the formation period is defined as in an up (down) state if the market return over the six-month period prior to the holding period is nonnegative (negative). The results indicate that market states in the formation period are positively associated with the profitability of the momentum strategies. The results are consistent with the overreaction theory developed in Daniel et al. (2004). Moreover, the empirical results indicate that market states in the holding period are negatively associated with the profitability of the momentum strategies. The holding period is defined as in an up (down) state if the market return in the six-month period following the formation period is nonnegative (negative). The momentum profits appear to be higher in a bearish holding period and lower for a bullish holding period. Thus, the market states in the holding period also provide information regarding the profitability of the momentum strategies.