Hostname: page-component-7b7567c8c-tnzcf Total loading time: 0 Render date: 2026-11-14T23:25:27.040Z Has data issue: false hasContentIssue false
  • English
  • Français

Crowding and Tail Risk in Momentum Returns

Published online by Cambridge University Press:  03 September 2021

Pedro Barroso,
Roger M. Edelen and
Paul KarehnkeOpen the ORCID record for Paul Karehnke[Opens in a new window]
Pedro Barroso
Affiliation:
Universidade Católica Portuguesa, Católica-Lisbon School of Business and Economics pedro.barroso@ucp.pt
Roger M. Edelen
Affiliation:
Virginia Tech Pamplin College of Business edelenr@vt.edu
Paul Karehnke*
Affiliation:
ESCP Business School
*
pkarehnke@escp.eu (corresponding author)
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the 'Save PDF' action button.

Several theoretical studies suggest that coordination problems can cause arbitrageur crowding to push asset prices beyond fundamental value as investors feedback trade on each others’ demands. Using this logic, we develop a crowding model for momentum returns that predicts tail risk when arbitrageurs ignore feedback effects. However, crowding does not generate tail risk when arbitrageurs rationally condition on feedback. Consistent with rational demands, our empirical analysis generally finds a negative relation between crowding proxies constructed from institutional holdings and expected crash risk. Thus our analysis casts both theoretical and empirical doubt on crowding as a stand-alone source of tail risk.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 4 , June 2022, pp. 1313 - 1342
Copyright
© The Author(s), 2021. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We are grateful to Semyon Malamud for comments that were particularly helpful to the article’s development. We are also grateful for helpful comments and suggestions from Jeff Busse, Jennifer Conrad (the editor), John Griffin, Philip Howard (the referee), Hening Liu, Steve Satchell, Rick Sias, Neal Stoughton, Xuemin Yan, and seminar participants at the University of Arizona, California Riverside, New South Wales, Newcastle, Paris-Dauphine, Technology at Sydney, Virginia Tech, EDHEC, INSEAD, Tennessee’s Smokey Mountain Finance Conference, The Annual IDC/Herzliya Conference and Annual Quantitative Trading Symposium, the Financial Risks International Forum, Manchester’s Hedge Fund Conference, the Portuguese Finance Network Conference, Rotterdam’s Professional Asset Management Conference, and the TCU Finance conference. Barroso acknowledges the support from the Portuguese Foundation for Science and Technology (FCT) for the project UIDP/00407/2020. The authors are solely responsible for errors.

References

Abreu, D., and Brunnermeier, M. K.. “Bubbles and Crashes.” Econometrica, 71 (2003), 173–204.10.1111/1468-0262.00393CrossRefGoogle Scholar
Andersen, T. G.; Bollerslev, T.; Diebold, F. X.; and Ebens, H.. “The Distribution of Stock Return Volatility.” Journal of Financial Economics, 61 (2001), 43–76.10.1016/S0304-405X(01)00055-1CrossRefGoogle Scholar
Ang, A. Asset Management: A Systematic Approach to Factor Investing. New York, NY: Oxford University Press (2014).10.1093/acprof:oso/9780199959327.001.0001CrossRefGoogle Scholar
Baltzer, M.; Jank, S.; and Smajlbegovic, E. “Who Trades on Momentum?” Journal of Financial Markets, 42 (2019), 56–74.10.1016/j.finmar.2018.08.003CrossRefGoogle Scholar
Barroso, P., and Santa-Clara, P.. “Momentum Has Its Moments.” Journal of Financial Economics, 116 (2015), 111–120.10.1016/j.jfineco.2014.11.010CrossRefGoogle Scholar
Black, F., and Scholes, M.. “The Valuation of Option Contracts and a Test of Market Efficiency.” Journal of Finance, 27 (1972), 399–417.10.2307/2978484CrossRefGoogle Scholar
Bollerslev, T. “Generalized Autoregressive Conditional Heteroskedasticity.” Journal of Econometrics, 31 (1986), 307–327.10.1016/0304-4076(86)90063-1CrossRefGoogle Scholar
Brown, G.; Howard, P.; and Lundblad, C.. “Crowded Trades and Tail Risk.” Working Paper, available at https://papers.ssrn.com/sol3/Papers.cfm?abstract_id=3326802 (2019).10.2139/ssrn.3326802CrossRefGoogle Scholar
Brunnermeier, M., and Pedersen, L. H.. “Market Liquidity and Funding Liquidity.” Review of Financial Studies, 22 (2009), 2201–2238.10.1093/rfs/hhn098CrossRefGoogle Scholar
Campbell, J. Y., and Viceira, L. M.. Strategic Asset Allocation: Portfolio Choice for Long-Term Investors. Oxford, UK: Oxford University Press (2002).10.1093/0198296940.001.0001CrossRefGoogle Scholar
Chabot, B.; Ghysels, E.; and Jagannathan, R.. “Momentum Trading, Return Chasing, and Predictable Crashes.” NBER Working Paper No. 20660 (2014).10.3386/w20660CrossRefGoogle Scholar
Cooper, M. J.; Gutierrez, R. C.; and Hameed, A.. “Market States and Momentum.” Journal of Finance, 59 (2004), 1345–1365.10.1111/j.1540-6261.2004.00665.xCrossRefGoogle Scholar
Daniel, K.; Jagannathan, R.; and Kim, S.. “A Hidden Markov Model of Momentum.” SSRN Working Paper (2019).Google Scholar
Daniel, K., and Moskowitz, T. J.. “Momentum Crashes.” Journal of Financial Economics, 122 (2016), 221–247.10.1016/j.jfineco.2015.12.002CrossRefGoogle Scholar
Edelen, R. M.; Ince, O. S.; and Kadlec, G. B.. “Institutional Investors and Stock Return Anomalies.” Journal of Financial Economics, 119 (2016), 472–488.10.1016/j.jfineco.2016.01.002CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.10.1016/0304-405X(93)90023-5CrossRefGoogle Scholar
George, T. J., and Hwang, C.-Y.. “The 52-Week High and Momentum Investing.” Journal of Finance, 59 (2004), 2145–2176.10.1111/j.1540-6261.2004.00695.xCrossRefGoogle Scholar
Grinblatt, M.; Jostova, G.; Petrasek, L.; and Philipov, A.. “Style and Skill: Hedge Funds, Mutual Funds, and Momentum.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2712050 (2016).Google Scholar
Grinblatt, M.; Titman, S.; and Wermers, R.. “Momentum Investment Strategies, Portfolio Performance, and Herding: A Study of Mutual Fund Behavior.” American Economic Review, 85 (1995), 1088–1105.Google Scholar
Gromb, D., and Vayanos, D.. “Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs.” Journal of Financial Economics, 66 (2002), 361–407.10.1016/S0304-405X(02)00228-3CrossRefGoogle Scholar
Grundy, B. D., and Martin, J. S. M.. “Understanding the Nature of the Risks and the Source of the Rewards to Momentum Investing.” Review of Financial Studies, 14 (2001), 29–78.10.1093/rfs/14.1.29CrossRefGoogle Scholar
Hong, H., and Stein, J. C.. “A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets.” Journal of Finance, 54 (1999), 2143–2184.10.1111/0022-1082.00184CrossRefGoogle Scholar
Huang, S. “The Momentum Gap and Return Predictability.” Review of Financial Studies, forthcoming (2022).10.1093/rfs/hhab093CrossRefGoogle Scholar
Hvidkjaer, S. “A Trade-Based Analysis of Momentum.” Review of Financial Studies, 19 (2006), 457–491.10.1093/rfs/hhj016CrossRefGoogle Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 65–91.CrossRefGoogle Scholar
Jones, C. M.; Kaul, G.; and Lipson, M. L.. “Transactions, Volume, and Volatility.” Review of Financial Studies, 7 (1994), 631–651.10.1093/rfs/7.4.631CrossRefGoogle Scholar
Khandani, A. E., and Lo, A. W.. “What Happened to the Quants in August 2007?” Journal of Investment Management, 5 (2007), 29–78.Google Scholar
Levy, R. A. “Relative Strength as a Criterion for Investment Selection.” Journal of Finance, 22 (1967), 595–610.10.1111/j.1540-6261.1967.tb00295.xCrossRefGoogle Scholar
Lewellen, J. “Institutional Investors and the Limits of Arbitrage.” Journal of Financial Economics, 102 (2011), 62–80.10.1016/j.jfineco.2011.05.012CrossRefGoogle Scholar
Lou, D., and Polk, C.. “Comomentum: Inferring Arbitrage Activity from Return Correlations.” Working Paper, London School of Economics (2013).CrossRefGoogle Scholar
Merton, R. C. “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29 (1974), 449–470.Google Scholar
Morris, S., and Shin, H. S.. “Liquidity Black Holes.” Review of Finance, 8 (2004), 1–18.10.1023/B:EUFI.0000022155.98681.25CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.10.2307/1913610CrossRefGoogle Scholar
Pedersen, L. H. “When Everyone Runs for the Exit.” The International Journal of Central Banking, 5 (2009), 177–199.Google Scholar
Peress, J. “Wealth, Information Acquisition, and Portfolio Choice.” Review of Financial Studies, 17 (2004), 879–914.10.1093/rfs/hhg056CrossRefGoogle Scholar
Piazzesi, M., and Schneider, M.. “Momentum Traders in the Housing Market: Survey Evidence and a Search Model.” American Economic Review, 99 (2009), 406–411.10.1257/aer.99.2.406CrossRefGoogle Scholar
Shleifer, A., and Vishny, R. W.. “The Limits of Arbitrage.” Journal of Finance, 52 (1997), 35–55.10.1111/j.1540-6261.1997.tb03807.xCrossRefGoogle Scholar
Sias, R.; Starks, L.; and Titman, S.. “Changes in Institutional Ownership and Stock Returns: Assessment and Methodology.” Journal of Business, 79 (2006), 2869–2910.10.1086/508002CrossRefGoogle Scholar
Stein, J. C. “Presidential Address: Sophisticated Investors and Market Efficiency.” Journal of Finance, 64 (2009), 1517–1548.10.1111/j.1540-6261.2009.01472.xCrossRefGoogle Scholar
White, H. “A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity.” Econometrica, 48 (1980), 817–838.10.2307/1912934CrossRefGoogle Scholar
Supplementary material: PDF

Barroso et al. supplementary material

Online Appendix

Download Barroso et al. supplementary material(PDF)
PDF 623 KB