Momentum is Still There Conditional on Volatility-Amplified Pessimism
67 Pages Posted: 24 Jan 2024 Last revised: 29 Jan 2024
Date Written: December 30, 2023
Abstract
We introduce an index of volatility-amplified pessimism (VAP) constructed from a representative agent asset pricing model with probability weighting. The model predicts momentum returns decrease in market volatility and pessimism, and predicts the opposite for the equity premium. Our real-time trading strategy uses the index to switch across different VAP states, and generates a large spread between momentum and market returns. In contrast, other momentum strategies have recently disappeared net of transaction costs. We find that momentum is still there, conditional on the interaction between the representative agent's pessimism and market volatility.
Keywords: Momentum; Empirical Asset Pricing; Probability Weighting
JEL Classification: D8, D81, G40, G41
Suggested Citation: Suggested Citation