Market Volatility and Momentum

Abstract

This paper investigates time-series predictability of momentum. Taking a hint from the drastic 2008-2009 episode, we examine whether market volatility is linked to momentum. We find that market volatility indeed has significant and robust predictive power for momentum profits, especially in negative market states. In contrast to the cross-sectional relation that momentum profitability is higher among firms with higher information uncertainty or higher default risk, our tests show that volatile down markets forecast low momentum payoffs. The time-series predictability of momentum is asymmetric, which arises from loser stocks. Jointly, these new findings raise a tough challenge to the existing theories on momentum. We explore whether default risk in down markets is related to the predictive power of market volatility and find supportive evidence.

Keywords: Market volatility, momentum effect, time-series predictability of momentum, asymmetric predictability, default risk, volatile down markets, realized volatility