Trading on a momentum opportunity

Abstract

There is an extensive academic literature that document that assets which have performed well in the past will continue to perform well over some holding period - so called momentum. The momentum effect has been found to disappear with time. The performance of the asset is modelled as a Brownian motion with positive drift, and for which the drift turns negative at an unobservable exponentially distributed random time. We investigate how an investor should trade optimally on a momentum opportunity to maximize her expected profit. We show also that the optimal boundary at which the investor should liquidate the trade depends monotonically on some model parameters.