Crowded Trades: Implications for Sector Rotation and Factor Timing

29 Pages Posted: 23 May 2018 Last revised: 3 Oct 2018

See all articles by William B. Kinlaw

William B. Kinlaw

State Street Global Exchange

Mark Kritzman

Massachusetts Institute of Technology (MIT) - Sloan School of Management

David Turkington

State Street Associates

Date Written: May 21, 2018

Abstract

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

Suggested Citation

Kinlaw, William B. and Kritzman, Mark and Turkington, David, Crowded Trades: Implications for Sector Rotation and Factor Timing (May 21, 2018). MIT Sloan Research Paper No. 5404-18. Available at SSRN: https://ssrn.com/abstract=3182664 or http://dx.doi.org/10.2139/ssrn.3182664

William B. Kinlaw

State Street Global Exchange ( email )

One Lincoln Street
Boston, MA 02111-2900
United States

Mark Kritzman (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

David Turkington

State Street Associates ( email )

United States

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