Momentum profits and time varying illiquidity effect

- Momentum profits are hedged against liquidity risk - for shorting loser portfolio.
- Momentum returns link with systematic liquidity is different from ease in trading.
- Contemporaneous systematic liquidity effect dominates the impact of lagged shocks on momentum profits.

We study the variations in the US momentum returns using shocks to contemporaneous and lagged market illiquidity. We assert that the momentum strategy is hedged against systematic illiquidity risk. The impact of systematic illiquidity risk on momentum profits is shown to be distinctive from the effect of supplying liquidity. Our results show that the contemporaneous effect of systematic illiquidity dominates the opposite prediction of lagged systematic illiquidity and retains its significance even if variables capturing the time varying exposures of momentum returns to market risk are included in the analysis.