Does Momentum Trading Generate Extra Downside Risk?
40 Pages Posted: 22 Feb 2014 Last revised: 22 Nov 2021
Date Written: June 29, 2020
Momentum strategies tend to provide low returns during market crashes, and they crash themselves when the market rebounds after significant crashes. This is reflected by positive downside market betas and negative upside market betas of zero-cost momentum portfolios. Such asymmetry in upside and downside risks is unfavorable for investors and requires a risk premium. It arises mechanically because of momentum portfolio rebalancing based on trailing asset performance. The asymmetry in upside and downside risks is a robust unifying feature of momentum portfolios in various geographical and asset markets. The momentum premium can be rationalized within a standard asset-pricing framework, where upside and downside risks are priced differently.
Keywords: momentum premium, momentum crashes, downside risk, downside beta, upside risk, upside beta, Downside-Risk CAPM
JEL Classification: G12, G14, G15
Suggested Citation: Suggested Citation