Does Momentum Trading Generate Extra Downside Risk?
57 Pages Posted: 22 Feb 2014 Last revised: 7 Jul 2020
Date Written: June 29, 2020
I provide a novel risk-based explanation for the profitability of momentum strategies. I show that past winners have higher extra downside risk and lower extra upside risk (on top of the market-beta risk) than past losers. As a result, the winner-minus-loser momentum portfolios are exposed to extra downside risk, but hedge against the upside risk, and this is compensated by a risk premium. Moreover, I show that this is not an inherent feature of the stocks in the winner and loser portfolios, but rather a result of portfolio rebalancing. The downside risk is orthogonal to the momentum risk and adds a risk premium to momentum returns. The downside risk is a robust unifying feature of momentum returns in various geographical and asset markets around the globe.
Keywords: momentum, downside risk, downside beta, upside risk, upside beta, Downside-Risk CAPM
JEL Classification: G12, G14, G15
Suggested Citation: Suggested Citation