Abstract
Despite momentum's strong historical performance, its returns have large negative skewness and occasionally experiences persistent strings of sharp negative returns, referred as in the recent literature. I argue that momentum crashes are due to crowded trades which push prices away from fundamentals leading to strong reversals, and exacerbated by limits of arbitrage being more severe in the short-leg due to impediments to short selling. Using short interest and institutional ownership data together to measure the crowdedness of momentum, I show that momentum crashes can be avoided in the cross section by shorting only non-crowded losers. There is considerably more short-covering during times when momentum fails. I show using high frequency short sale transactions data that short covering is especially severe in the crowded loser portfolio. A placebo test using a set of 63 futures contracts show that momentum crashes do not exist in futures market after market exposure is correctly hedged, which is consistent with my hypothesis.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
