Working Paper: NBER ID: w20439
Authors: Kent Daniel; Tobias J. Moskowitz
Abstract: Despite their strong positive average returns across numerous asset classes, momentum strategies can experience infrequent and persistent strings of negative returns. These momentum crashes are partly forecastable. They occur in "panic" states - following market declines and when market volatility is high - and are contemporaneous with market rebounds. We show that the low ex-ante expected returns in panic states are consistent with a conditionally high premium attached to the option-like payoffs of past losers. An implementable dynamic momentum strategy based on forecasts of momentum's mean and variance approximately doubles the alpha and Sharpe Ratio of a static momentum strategy, and is not explained by other factors. These results are robust across multiple time periods, international equity markets, and other asset classes.
Keywords: No keywords provided
JEL Codes: G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market conditions (P42) | performance of momentum strategies (G41) |
| market declines (G10) | momentum crashes (E32) |
| high volatility (C58) | momentum crashes (E32) |
| panic states (C62) | low expected returns (G12) |
| past losers (D44) | high premium on option-like payoffs (G13) |
| dynamic momentum strategy (C69) | improved performance metrics (C52) |
| dynamic momentum strategy (C69) | alpha (Y60) |
| dynamic momentum strategy (C69) | Sharpe ratio (G11) |
| momentum premium (C69) | performance of momentum strategies (G41) |
| volatility (E32) | performance of momentum strategies (G41) |