Tail Risk in Momentum Strategy Returns

35 Pages Posted: 5 Jun 2012

See all articles by Kent D. Daniel

Kent D. Daniel

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Ravi Jagannathan

Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER); Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF); Indian School of Business (ISB), Hyderabad

Soohun Kim

College of Business, Korea Advanced Institute of Science and Technology (KAIST)

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2012

Abstract

Price momentum strategies have historically generated high positive returns with little systematic risk. However, these strategies also experience infrequent but severe losses. During 13 of the 978 months in our 1929-2010 sample, losses to a US-equity momentum strategy exceed 20 percent per month. We demonstrate that a hidden Markov model in which the market moves between latent "turbulent'' and "calm'' states in a systematic stochastic manner captures these high-loss episodes. The turbulent state is infrequent in our sample: the probability that the hidden state is turbulent is greater than one-half in only 20% of the months in our sample. Yet in each of the 13 severe loss months, the ex-ante probability that the hidden state is turbulent exceeds 70 percent. This strong forecastability accentuates the price momentum puzzle.

Suggested Citation

Daniel, Kent D. and Jagannathan, Ravi and Kim, Soohun, Tail Risk in Momentum Strategy Returns (June 1, 2012). Available at SSRN: https://ssrn.com/abstract=2076622 or http://dx.doi.org/10.2139/ssrn.2076622

Kent D. Daniel (Contact Author)

Columbia Business School - Finance and Economics ( email )

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Ravi Jagannathan

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Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

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Indian School of Business (ISB), Hyderabad ( email )

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Soohun Kim

College of Business, Korea Advanced Institute of Science and Technology (KAIST) ( email )

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Seoul 02455
Korea, Republic of (South Korea)

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