NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Soohun Kim

Finance Department, Kellogg School of Management,
Evanston
IL 60208

E-Mail: EmailAddress: hidden: you can email any NBER-related person as first underscore last at nber dot org

NBER Working Papers and Publications

June 2012Tail Risk in Momentum Strategy Returns
with Kent Daniel, Ravi Jagannathan: w18169
Momentum strategies exhibit rare but dramatic losses (crashes), which we show are a result of the leverage dynamics of stocks in the momentum portfolio. When the economy is in a hidden turbulent state associated with a depressed and volatile stock market, the short-side of the momentum portfolio becomes highly levered, and behaves like a call option on the market index portfolio, making momentum crashes more likely. We develop a hidden Markov model of the unobserved turbulent state that affects the returns on the momentum strategy and the market index portfolios. We find that the use of a combination of Normal and Student-t distributions for the hidden residuals in the model to construct the likelihood of the realized momentum and market index returns dramatically improves the models abili...
 
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