Abstract
We provide robust evidence of momentum crashes within the Asian region, which occurred following the Asian financial crisis and the global financial crisis. The probability of a momentum crash is time-varying; it increases after periods of low market returns and high cross-sectional return dispersion when the beta of the zero-investment momentum portfolio becomes negative. Under cumulative prospect theory, investors overweight the probability of a momentum crash when estimating their value function, resulting in the price of “winners” decreasing and future average returns increasing. Consistent with this theory, we show that momentum returns in Asia are substantially lower following periods where the probability of a momentum crash is higher. Therefore, we argue that the negative (positive) skewness of winner (loser) portfolios is priced and may explain the momentum premium.
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