Momentum Crashes and Variations to Market Liquidity
41 Pages Posted: 14 Jan 2019
Date Written: January 11, 2019
We document that the variation in market liquidity is an important determinant of momentum crashes that is independent of other known explanations surfaced on this topic. This relationship is driven by the asymmetric large return sensitivity of short-leg of momentum portfolio to changes in market liquidity that flares the tail risk of momentum strategy in panic states. This identification explains the forecasting ability of known predictors of tail risk of momentum strategy such that the contemporaneous increase in market liquidity predominantly sums up the trademark negative relationship between predictors and future momentum returns. Our results are robust using a different momentum portfolio and alternative measures of market liquidity that make a substantial part of the common source of variation in aggregate liquidity.
Keywords: market liquidity, momentum crashes, tail risk, predictors
JEL Classification: G10, G12, G15
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