Crowding and Tail Risk in Momentum Returns
69 Pages Posted: 1 Oct 2017 Last revised: 17 Oct 2020
Date Written: March 19, 2019
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: Suggested Citation