Tail Risk in Momentum Strategy Returns

Kent Daniel, Ravi Jagannathan and Soohun Kim

No 18169, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Price momentum strategies have historically generated high positive returns with little systematic risk. However, these strategies also experience infrequent but severe losses. During 13 of the 978 months in our 1929-2010 sample, losses to a US-equity momentum strategy exceed 20 percent per month. We demonstrate that a hidden Markov model in which the market moves between latent "turbulent" and "calm" states in a systematic stochastic manner captures these high-loss episodes. The turbulent state is infrequent in our sample: the probability that the hidden state is turbulent is greater than one-half in only 20% of the months. Yet in each of the 13 severe loss months, the ex-ante probability that the hidden state is turbulent exceeds 70 percent. This strong forecastability accentuates the price momentum puzzle; a conditional momentum strategy that moves to the risk-free asset when the ex-ante probability of the turbulent state is high exhibits dramatically better performance than the unconditional momentum strategy.

JEL-codes: G01 G11 G12 G13 G14 (search for similar items in EconPapers)
Date: 2012-06
Note: AP
References: Add references at CitEc
Citations Track citations by RSS feed

Downloads: (external link)
http://www.nber.org/papers/w18169.pdf (application/pdf)
Access to the full text is generally limited to series subscribers, however if the top level domain of the client browser is in a developing country or transition economy free access is provided. More information about subscriptions and free access is available at http://www.nber.org/wwphelp.html. Free access is also available to older working papers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:nbr:nberwo:18169

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w18169
The price is Paper copy available by mail.

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc
Address: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Contact information at EDIRC.
Series data maintained by ().