Aggregate Volatility Risk and Momentum Returns
80 Pages Posted: 11 Jun 2012 Last revised: 6 Jun 2018
Date Written: October 2017
Abstract
Momentum stocks are exposed to aggregate volatility risk. This paper estimates an EGARCH model of market volatility to introduce a new volatility risk factor that prices itself, and thereby becomes a candidate risk factor for analyzing stock market anomalies such as momentum. Winners have negative loadings on this new volatility factor, whereas losers have positive loadings. Since volatility risk carries a negative price of risk, the new factor helps explain 81% of momentum profits. The paper also rationalizes the volatility risk exposures of momentum portfolios and the short life of profits using event studies and growth option arguments.
Keywords: Momentum, aggregate volatility, growth options, corporate investment, event study
JEL Classification: G12, G14
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