Three Insights from Academic Research Related to Momentum Strategy Thursday, 4 April, 2019

What are the main insights?

- momentum is not an anomaly in a risk-based asset pricing framework. Riskier assets tend to be in the loser portfolios after (large) increases in the price of risk. The risk of momentum portfolios usually decreases with the prevailing price of risk, and their risk premiums are approximately negative quadratic functions of the price of risk (and the market premium) theoretically truncated at zero.

- changes to market liquidity adds to the explanation of momentum crashes along with the market rebounds, this relationship is driven by the asymmetric large return sensitivity of short-leg of momentum portfolio to changes in market liquidity that flares the tail risk of momentum strategy in panic states

- momentum returns are highly related to market risk arising from return dispersion (RD) as momentum risk loadings and RD risk loadings are similarly priced in momentum portfolios

1/

Author: Souza

Title: A Critique of Momentum Anomalies

Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3341275

Abstract:

This paper offers theoretical, empirical, and simulated evidence that momentum regularities in asset prices are not anomalies. Within a general, frictionless, rational expectations, risk-based asset pricing framework, riskier assets tend to be in the loser portfolios after (large) increases in the price of risk. Hence, the risk of momentum portfolios usually decreases with the prevailing price of risk, and their risk premiums are approximately negative quadratic functions of the price of risk (and the market premium) theoretically truncated at zero. The best linear (CAPM) function describing this relation unconditionally has exactly the negative slope and positive intercept documented empirically.

2/

Authors: Butt, Virk

Title: Momentum Crashes and Variations to Market Liquidity

Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3314095

Abstract:

We document that the variation in market liquidity is an important determinant of momentum crashes that is independent of other known explanations surfaced on this topic. This relationship is driven by the asymmetric large return sensitivity of short-leg of momentum portfolio to changes in market liquidity that flares the tail risk of momentum strategy in panic states. This identification explains the forecasting ability of known predictors of tail risk of momentum strategy such that the contemporaneous increase in market liquidity predominantly sums up the trademark negative relationship between predictors and future momentum returns. Our results are robust using a different momentum portfolio and alternative measures of market liquidity that make a substantial part of the common source of variation in aggregate liquidity.

3/

Authors: Kolari, Liu

Title: Market Risk and the Momentum Mystery

Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3280559

Abstract:

This paper employs the ZCAPM asset pricing model of Liu, Kolari, and Huang (2018) to show that momentum returns are highly related to market risk arising from return dispersion (RD). Cross-sectional tests show that momentum risk loadings and RD risk loadings are similarly priced in momentum portfolios. Comparative analyses find that zero-investment momentum portfolios and zero-investment return dispersion portfolios earn high returns relative to other risk factors. Further regression tests indicate that zero-investment momentum returns are very significantly related to zero-investment return dispersion returns. We conclude that the momentum mystery is explained by market risk associated with return dispersion for the most part.


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