Keep up the momentum
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The pricing mechanisms that lay behind the momentum risk premium, which is seen as one of the most important alternative risk premia alongside the carry premium, seem not well understood. In the finance literature, there is no consensus on whether a momentum investment gears towards asset selection (alpha) or rather towards a systematic exposure to risk (beta). Does selecting the trending assets within a market introduce a skew or convexity into the expected return distribution? Does it modify the price correlation relationships with respect to other positions that are taken in a portfolio? The goal of this paper is to address these questions and define what momentum investing stands for. What characterises momentum investing is to us its capacity to diversify which is particularly pronounced in stressed markets. This market-timing aspect we observe is of interest for long investors, as the price decorrelation that is provoked comes when it is most needed. We make evident that the diversification asymmetry is less relevant for a long–short absolute-return investment.
KeywordsMomentum Trend-following Diversification Payoff
JEL ClassificationC50 C60 G11
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