Equity Momentum: Winner and Loser Portfolios, Crash Risk, and Risk Management
Summary
The document explains cross-sectional stock momentum: rank stocks by their prior returns, then buy recent winners and sell recent losers. Its example uses a 12-month formation period that excludes the latest month to reduce microstructure and liquidity biases. The strategy is described as persistent across U.S., developed, and emerging equity markets, and in both small- and large-cap stocks. The cited research also finds that momentum can contribute to long-only portfolios, with profits often stronger on the long side.
The main caveat is crash risk. The document reports a severe 2009 drawdown for a pure long-short portfolio and says momentum can fall sharply when markets rebound after large declines, limiting its usefulness as a hedge. It discusses behavioral explanations such as underreaction and herding, while acknowledging risk-based explanations. It also cites evidence that managing time-varying risk may improve risk efficiency, but provides no full implementation, transaction-cost analysis, or independent evaluation of the reported results.
Key ideas
- Cross-sectional momentum ranks stocks by past returns and takes long positions in winners while shorting losers.
- A common specification uses the prior year’s returns while skipping the most recent month.
- The document describes evidence for momentum across regions and market-cap segments.
- Long-short momentum can suffer severe losses during sharp market rebounds after declines.
- Behavioral underreaction and exposure to omitted risks are presented as possible explanations.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.