Momentum Crashes

Table of Contents

• Introduction
• The Momentum Investment Strategy – a General Overview
  • Mode of Operation
  • Sources of Momentum
  • Momentum in Equities and Other Asset Categories
  • Correlation with the Fama French Factors
• Data, Construction and Application of the Momentum Portfolio
  • Data Origin and Portfolio Construction
  • Application of the Portfolio
• Momentum Crashes
  • The Major Crash Periods
  • Crash Triggers
    • Skewness and Kurtosis
    • Bear Markets and Portfolio Betas
    • Non-Linearity of Market Returns in and after Bear Markets
• The 2009 Momentum Crash – a Detailed Analysis
  • Qualitative Analysis: Companies in the Winner and Loser Portfolio
  • Quantitative Analysis: Insights into risk, size, trading volume, and value factors

Objectives and Key Themes

This paper investigates the characteristics of periods of extreme underperformance in momentum investment strategies, focusing specifically on the 2009 momentum crash. The research aims to understand the portfolio composition during this crash and quantitatively evaluate the momentum portfolio's performance using common indicators, comparing it to a non-crash benchmark period.

• Characteristics of momentum crashes
• Analysis of the 2009 momentum crash
• Quantitative evaluation of momentum portfolio performance
• Comparison of crash and non-crash periods
• Underlying factors contributing to momentum crashes

Chapter Summaries

Introduction: This introductory chapter establishes the foundation for the research by explaining the momentum investment strategy and its general effectiveness. It highlights the surprisingly high excess returns yielded by this seemingly simple strategy, while acknowledging the existence of periods of significant underperformance, exemplified by the substantial losses during the 2009 momentum crash. The chapter outlines the paper's focus on analyzing the structure and characteristics behind these periods of poor performance, specifically focusing on the 2009 crash. The remaining sections of the paper are previewed, detailing the breakdown of the research. The introduction sets the stage for a detailed investigation into the intricacies and risks associated with momentum investing.

The Momentum Investment Strategy – a General Overview: This section provides a comprehensive overview of the momentum investment strategy. It explains the operational mechanism of the strategy, which involves identifying and investing in past "winner" stocks while shorting "loser" stocks. The chapter explores the sources of momentum, examining why this seemingly simple strategy generates excess returns. Further, it demonstrates that momentum is not limited to equity markets, expanding its applicability beyond stocks. The chapter also establishes that momentum returns are not easily explained by traditional factors such as those proposed in the Fama-French three-factor model, suggesting the presence of unique characteristics driving momentum profits.

Data, Construction and Application of the Momentum Portfolio: This chapter details the methodology employed in the study. It meticulously outlines the data sources utilized for the replication of the momentum strategy over the period of 1927 to 2012. A precise description of the portfolio construction process is given, including the methods used to identify "winner" and "loser" stocks and to build the corresponding portfolios. This section provides the reader with a crucial understanding of how the data was obtained and processed, ensuring reproducibility and transparency in the research's methodology. The chapter also elucidates the application of the constructed portfolio, illustrating how it was used to generate returns and subsequently analyzed.

Momentum Crashes: This pivotal chapter delves into the phenomenon of momentum crashes, those periods of extreme underperformance experienced by the momentum investment strategy. The chapter identifies and analyzes major crash periods throughout history, using detailed data to establish the characteristics and timeline of these events. Crucially, it investigates the potential triggers for these crashes, examining factors such as market skewness, kurtosis, the impact of bear markets, and the non-linearity of market returns both during and following bear markets. The analysis in this chapter provides valuable insights into the risk profile inherent in momentum investing, highlighting the potential for catastrophic losses despite the strategy's typically high returns. The identification of potential triggers provides critical risk management implications for practitioners of momentum investing.

Keywords

Momentum strategy, momentum crashes, portfolio construction, risk factors, market returns, Fama-French factors, quantitative analysis, qualitative analysis, bear markets, 2009 financial crisis.

Frequently Asked Questions: A Comprehensive Analysis of Momentum Crashes, Focusing on the 2009 Event

What is the main topic of this research paper?

This research paper investigates the characteristics of extreme underperformance periods ("crashes") within momentum investment strategies, with a particular focus on the significant downturn experienced in 2009. It aims to understand the portfolio composition during this crash and quantitatively assess the momentum portfolio's performance using various indicators, comparing it to periods without such crashes.

What is a momentum investment strategy?

A momentum investment strategy involves identifying and investing in previously successful ("winner") stocks while simultaneously shorting underperforming ("loser") stocks. The strategy leverages the tendency of past winners to continue outperforming and past losers to continue underperforming, though this trend is not always consistent.

What are the key themes explored in the paper?

Key themes include the characteristics of momentum crashes, a detailed analysis of the 2009 momentum crash, quantitative evaluation of momentum portfolio performance during both crash and non-crash periods, and an investigation into the underlying factors that contribute to these crashes.

How is the momentum portfolio constructed?

The paper meticulously details the data sources (spanning 1927-2012) and methodology used to construct the momentum portfolio. It explains the process of identifying "winner" and "loser" stocks and the methods employed to build the corresponding portfolios. This ensures transparency and reproducibility of the research.

What are the key findings regarding the 2009 momentum crash?

The paper provides both qualitative (analysis of companies in winner and loser portfolios) and quantitative (analysis of risk, size, trading volume, and value factors) insights into the 2009 crash. It compares the performance of the momentum portfolio during this crash with its performance during non-crash periods.

What factors contribute to momentum crashes?

The research explores several potential triggers for momentum crashes, including market skewness and kurtosis, the impact of bear markets, and the non-linearity of market returns during and after bear markets. The goal is to understand and potentially mitigate the risks associated with these significant downturns.

What is the significance of comparing the 2009 crash to non-crash periods?

Comparing the 2009 crash to periods of normal momentum performance allows for a more robust assessment of the risk profile of momentum investing. It highlights the potential for extreme losses and underscores the importance of understanding the factors contributing to these events.

What is the relationship between momentum returns and the Fama-French factors?

The paper examines the correlation between momentum returns and the Fama-French factors (size, value, and market risk). It suggests that momentum returns are not easily explained by these traditional factors, indicating the presence of unique characteristics driving momentum profits and losses.

What are the practical implications of this research?

This research provides valuable insights into the risk profile of momentum investing, helping practitioners better understand and manage the potential for significant losses during periods of extreme market underperformance. It offers a deeper understanding of the factors that may trigger such crashes.

What are the keywords associated with this research?

The keywords include: Momentum strategy, momentum crashes, portfolio construction, risk factors, market returns, Fama-French factors, quantitative analysis, qualitative analysis, bear markets, and the 2009 financial crisis.