DP19030 Taming Momentum Crashes
The return on conventional momentum portfolios exhibits a predominantly negative, time-varying skewness, which deepens during the so-called momentum ``crashes''. This has important implications for the dynamic of the risk-return trade-off associated with momentum investing: the relationship between the strategy's expected return and volatility is time-varying and depends on conditional skewness. We explore the economic underpinnings of time-varying skewness by timing the capital exposure to momentum portfolios in response to fluctuations in risk. The results show that a dynamic skewness-adjusted maximum Sharpe ratio strategy significantly improves upon popular volatility scaling approaches. Finally, we show that the dynamic of the momentum return skewness cannot be fully reconciled with an asymmetric exposure to upside and downside market risk.
