Maximum Drawdown, Recovery, and Momentum

Jaehyung Choi
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Jaehyung Choi: Goldman Sachs & Co., New York, NY 10282, USA

JRFM, 2021, vol. 14, issue 11, 1-25

Abstract: We empirically test predictability on asset price using stock selection rules based on maximum drawdown and its consecutive recovery. In various equity markets, monthly momentum- and weekly contrarian-style portfolios constructed from these alternative selection criteria are superior not only in forecasting directions of asset prices but also in capturing cross-sectional return differentials. In monthly periods, the alternative portfolios ranked by maximum drawdown measures exhibit outperformance over other alternative momentum portfolios including traditional cumulative return-based momentum portfolios. In weekly time scales, recovery-related stock selection rules are the best ranking criteria for detecting mean-reversion. For the alternative portfolios and their ranking baskets, improved risk profiles in various reward-risk measures also imply more consistent prediction on the direction of assets in future. Moreover, turnover rates of these momentum/contrarian portfolios are also reduced with respect to the benchmark portfolios. In the Carhart four-factor analysis, higher factor-neutral intercepts for the alternative strategies are another evidence for the robust prediction by the alternative stock selection rules.

Keywords: momentum; mean-reversion; maximum drawdown; recovery; alternative stock selection rules (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2021
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