Momentum and Downside Risk

We find that momentum strategy is exposed to economic downside risk. Momentum strategy generates economically large negative profits in bad economic states, while positive profits in good economic states. Our inferences differ from previous studies because we define states of nature based on the ex-ante expected market risk premium, rather than the ex-post realized market return, which is a noisy measure for marginal utility or business cycle. Our findings suggest that time variation in momentum strategy is linked to variations in macroeconomic risk. JEL classification: G1