Residual Momentum and Investor Underreaction in Japan

We document that the residual momentum strategy, which is constructed to hedge out the risk exposure to the Fama-French factors, is profitable in Japan for short-term holding periods. Residual momentum profits over long-term holding periods are insignificant but do not reverse, unlike traditional total return momentum strategies observed in the U.S. market. The findings in both short- and long-term holding periods are attributed to investor underreaction. The role of investor underreaction remains robust to the control of the confounding variables (such as institutional ownership, idiosyncratic volatilities, and firm age) that are known to lead investor limited attention.