Risky Value Meets Behavioral Momentum
59 Pages Posted: 8 Apr 2022 Last revised: 16 Oct 2024
Date Written: January 10, 2022
Abstract
This paper demonstrates that risk-based and behavioral cross-sectional asset pricing anomalies can plausibly coexist. To this end, I build a model in which risk-based value premium exists along with behavioral momentum. The value premium stems from differential exposures of stocks to rare disaster risk. Momentum is the result of behavioral underreaction to firm-specific news. The model reproduces several key patterns about value and momentum factor returns, including average excess returns, factors' correlation and the failure of CAPM in explaining both anomalies. The model also generates the reversal of momentum returns precisely due to the existence of a persistent value premium. The behavior of value and momentum during market crashes lends support to the model mechanism.
Keywords: mispricing, momentum, rare disasters, value premium
JEL Classification: G12, G40
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