Decomposing Momentum: Eliminating its Crash Component
71 Pages Posted: 19 Jul 2021 Last revised: 24 Feb 2022
Date Written: July 15, 2021
We propose a purely cross-sectional momentum strategy that avoids crash risk and does not depend on the state of the market. To do so, we simply split up the standard momentum return over months t-12 to t-2 at the highest stock price within this formation period. Both resulting momentum return components predict subsequent returns on a stand-alone basis. However, the long-short returns associated with the first component completely avoid negative skewness as the momentum crashes are driven by the second component's short leg dependence on recent loser stocks. The crash-resilient strategy allows for significant momentum profits even in recent years, avoids the latest Covid-19 momentum crash, and is valid in both the US and international stock markets.
Keywords: Momentum, Momentum crashes, 52-Week high, Cross-section of stock returns
JEL Classification: G11, G12
Suggested Citation: Suggested Citation