Crowded Trades: Implications for Sector Rotation and Factor Timing
29 Pages Posted: 23 May 2018 Last revised: 3 Oct 2018
Date Written: May 21, 2018
Crowded trades are often associated with bubbles. If investors can locate a bubble sufficiently early they can profit from the run up in prices. But in order to profit from a bubble investors must exit the bubble before the selloff erodes all of the profits. The authors propose two measures for managing exposure to bubbles. One measure, called asset centrality, locates crowded trading which they show is often associated with the formation of bubbles. The other is a measure of relative value, which helps to separate crowding that occurs during a bubble’s run-up from crowding that occurs during a bubble’s sell-off. Neither measure by itself is sufficient for identifying the full cycle of a bubble, but the authors show that together these measures have the potential to locate bubbles in sectors as well as in factors as they begin to emerge and to identify exit points before they fully deflate.
Keywords: Absorption ratio, Asset centrality, Bubble, Crowded trade, Deflationary crowding, Fundamental value, Inflationary crowding, Relative value
JEL Classification: C10 ,G01, G02, G11, G12
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