Crowding and Tail Risk in Momentum Returns

69 Pages Posted: 1 Oct 2017 Last revised: 17 Oct 2020

See all articles by Pedro Barroso

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics

Roger M. Edelen

Virginia Tech

Paul Karehnke

ESCP Business School

Date Written: March 19, 2019

Abstract

Several theoretical studies suggest that coordination problems can cause arbitrageur crowding to push asset prices beyond fundamental value as investors feedback trade on each others' demands. Using this logic we develop a crowding model for momentum returns that predicts tail risk when arbitrageurs ignore feedback effects. However, crowding does not generate tail risk when arbitrageurs rationally condition on feedback. Consistent with rational demands, our empirical analysis generally finds a negative relation between crowding proxies constructed from institutional holdings and expected crash risk. Thus our analysis casts both theoretical and empirical doubt on crowding as a stand-alone source of tail risk.

Keywords: Momentum, crash risk, institutional investors, crowded trade, destabilize

JEL Classification: G11, G12, G14

Suggested Citation

Barroso, Pedro and Edelen, Roger M. and Karehnke, Paul, Crowding and Tail Risk in Momentum Returns (March 19, 2019). Available at SSRN: https://ssrn.com/abstract=3045019 or http://dx.doi.org/10.2139/ssrn.3045019

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics ( email )

Palma de Cima
Lisbon, Lisboa 1649-023
Portugal

HOME PAGE: http://https://clsbe.lisboa.ucp.pt/person/pedro-monteiro-e-silva-barroso

Roger M. Edelen

Virginia Tech ( email )

1016 Pamplin Hall (0221)
Blacksburg, VA 24060-0221
United States

Paul Karehnke (Contact Author)

ESCP Business School ( email )

79 avenue de la République
75011
France

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