Upside and Downside Risks in Momentum Returns

66 Pages Posted: 25 Nov 2015

See all articles by Victoria Dobrynskaya

Victoria Dobrynskaya

National Research University Higher School of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: November 24, 2015

Abstract

I provide a novel risk-based explanation for the profitability of momentum strategies. I show that the past winners and the past losers are differently exposed to the upside and downside market risks. Winners systematically have higher relative downside market betas and lower relative upside market betas than losers. As a result, the winner-minus-loser momentum portfolios are exposed to extra downside market risk, but hedge against the upside market risk. Such asymmetry in the upside and downside risks is a mechanical consequence of rebalancing momentum portfolios. But it is unattractive for an investor because both positive relative downside betas and negative relative upside betas carry positive risk premiums according to the Downside-Risk CAPM. Hence, the high returns to momentum strategies are a mere compensation for their upside and downside risks. The Downside Risk-CAPM is a robust unifying explanation of returns to momentum portfolios, constructed for different geographical and asset markets, and it outperforms alternative multi-factor models.

Keywords: momentum, downside risk, downside beta, upside risk, upside beta, Downside-Risk CAPM

JEL Classification: G12, G14, G15

Suggested Citation

Dobrynskaya, Victoria, Upside and Downside Risks in Momentum Returns (November 24, 2015). Higher School of Economics Research Paper No. WP BRP 50/FE/2015. Available at SSRN: https://ssrn.com/abstract=2695001 or http://dx.doi.org/10.2139/ssrn.2695001

Victoria Dobrynskaya (Contact Author)

National Research University Higher School of Economics ( email )

26, Shabolovka st.
Moscow, 119017
Russia

HOME PAGE: http://www.hse.ru

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