Stock Neighborhood Momentum Effect

Can investors make the stock return momentum effect stronger/more reliable by isolating stocks for which many similar stocks exhibit very strong or very weak past returns? In his December 2022 paper entitled “Neighbouring Assets”, Sina Seyfi explores this question by sorting stocks based on average past returns of other stocks with the most similar sets of 94 characteristics (neighbor stocks). He measures similarity between two stocks as the aggregate distance of their normalized and winsorized (excluding top and bottom 1% of values) characteristics over a baseline rolling 10-year history. His baseline “neighborhood” is 1,000 stocks. His baseline past return metric is average monthly value-weighted return of neighbor stocks over the past year. He considers three stock universes, consisting of all NYSE/AMEX/NASDAQ stocks: (1) excluding the 5% with the smallest market capitalizations; (2) excluding those below the 20% breakpoint of NYSE market capitalizations; and, (3) excluding those below the median of NYSE market capitalizations. He each month sorts stocks into tenths (deciles) of average past return of neighborhood stocks and reforms a value-weighted portfolio that is long (short) those in the decile with the highest (lowest) neighbor-stock average past return. Using monthly characteristics and returns for the specified stocks during January 1970 (with portfolio formation commencing January 1980) through December 2021, he finds that: (more…)