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Momentum and Contrarian Profits and Macroeconomic Fundamentals

We show that the existence of momentum and contrarian profits imposes restrictions on stochastic discount factors used to price stocks in equity markets. For several widely used asset pricing models, we demonstrate that these restrictions imply testable forms of intertemporal dependence in macroeconomic fundamentals such as consumption growth rate. Extensive empirical analysis provides supporting evidence that the momentum and contrarian profits manifest the short-term continuation and the longterm reversal in the macroeconomic fundamentals. Intuitively, the dynamics of the macroeconomic fundamentals induces a common return persistence for individual stocks. When coupled with the selection of past winners and losers, the return persistence generates the momentum and contrarian profits.