Abstract
AbstractWe document that the variation in market liquidity is an important determinant of momentum crashes that is independent of other known explanations. This relationship is driven by the asymmetric large return sensitivity of short‐leg of momentum portfolio to changes in market liquidity that increases the tail risk of the momentum strategy in panic states. Identifying this partly explains the forecasting ability of known predictors of tail risk of the momentum strategy. The contemporaneous increase in market liquidity explains, to some extent, the documented negative relationship between predictors and future momentum returns. Our findings are robust to the use of alternative measures of market liquidity that share a common source of variation in aggregate liquidity.
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