Momentum Investing: A Comparative Analysis of Efficiency and Profitability in the BSE 500 and the S&P 500

Abstract

This thesis explores the effectiveness of momentum investing as a strategy to enhance portfolio returns by examining its performance within the BSE 500 and the S&P 500 indices from January 2000 to January 2024. Momentum investing, defined as the strategy of buying securities that have shown strong recent performance and selling those with weak recent performance, has consistently attracted attention due to its potential for generating alpha independent of traditional market risk. The study employs a empirical approach, constructing 16 overlapping long-short momentum portfolios based on four distinct formation periods (3, 6, 9, and 12 months) paired with corresponding holding periods. A critical evaluation of these portfolios is conducted by adjusting returns for bid-ask spreads, brokerage fees, and other transaction-related expenses sourced from Bloomberg and WRDS databases. Performance assessment encompasses risk-adjusted metrics such as annualized Sharpe ratios, CAPM alphas, and detailed crash-risk analyses, alongside Fama-MacBeth cross-sectional regressions to estimate the pricing of momentum risk. Comparative analysis between the highly efficient and liquid S&P 500 market and the less efficient BSE 500 market aims to reveal insights into how market characteristics, liquidity constraints, and investor behavior influence the effectiveness of momentum strategies. The research notably investigates the frequency and severity of momentum crashes in both markets, examining how conditional indicators such as market volatility and liquidity spreads might be utilized to mitigate downside risks. Findings highlight the conditions under which momentum strategies deliver net positive returns after accounting for crash risks, providing practical guidance for investors on implementing momentum strategies across different market contexts. Ultimately, this thesis contributes to the understanding of momentum investing by clarifying its limitations, potential, and strategic adaptations necessary for consistent outperformance.