Momentum, Risk, and Underreaction

37 Pages Posted: 17 Jun 2012 Last revised: 20 Jul 2012

See all articles by Mark Rachwalski

Mark Rachwalski

Emory University - Department of Finance

Quan Wen

Georgetown University - Department of Finance

Date Written: June 11, 2012

Abstract

Momentum profits can be explained by exposure to risks omitted from common factor models (distress risk, idiosyncratic risk, and covariance with corporate bonds) and underreaction to innovations in these risks. Momentum strategies tend to go long risky stocks with high expected returns. Consistent with risk as a partial explanation of momentum profits, long formation period momentum strategies earn higher returns and are more highly correlated with risk factors than short formation period momentum strategies. Momentum strategies also tend to go short stocks with recent increases in risk; these stocks have low expected returns because investors underreact to risk innovations.

Keywords: Momentum, Risk, Underreaction

JEL Classification: G12, G14

Suggested Citation

Rachwalski, Mark and Wen, Quan, Momentum, Risk, and Underreaction (June 11, 2012). Available at SSRN: https://ssrn.com/abstract=2085340 or http://dx.doi.org/10.2139/ssrn.2085340

Mark Rachwalski (Contact Author)

Emory University - Department of Finance ( email )

201 Dowman Drive
Atlanta, GA 30322
United States

Quan Wen

Georgetown University - Department of Finance ( email )

37th and O Street, NW
Washington D.C., DC 20057
United States

HOME PAGE: http://faculty.georgetown.edu/qw50

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