Myopic Loss Aversion: An Alternative Explanation of the Momentum Premium

Abstract

Returns to both traditional and risk-managed momentum strategies are non-normal, reducing the efficacy of the Sharpe ratio as an evaluation tool. To account for the higher moments of the return distribution, we evaluate momentum using the framework of myopic loss aversion. Under this framework, traditional momentum strategies are no longer anomalous and risk-managed strategies can be explained where institutional investors frequently evaluate their portfolios. We extend this result and explore the impact of myopia over an international sample. Consistent with the predictions of myopic loss aversion, we find that the momentum premium is higher for countries that are predisposed to myopia. We therefore argue that myopic loss aversion provides an alternative explanation for the momentum premium.

Keywords: Myopic loss aversion; momentum drawdown; cumulative prospect theory; culture

JEL Classification: G11, G12