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Tail Risk in Momentum Strategy Returns

35 Pages Posted: 5 Jun 2012  

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

Georgia Institute of Technology - Scheller College of Business

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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HOME PAGE: http://www.columbia.edu/~kd2371/

National Bureau of Economic Research (NBER)

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Ravi Jagannathan

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
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Evanston, IL 60208
United States
847-491-8338 (Phone)
847-491-5719 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

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

Hyderabad, Gachibowli 500 019
India

Soohun Kim

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

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