Short selling

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Philip Yany

Princeton University

November, 2013

Abstract

Despite momentums strong historical performance, its returns have large negative skewness

and occasionally experiences persistent strings of sharp negative returns, referred as momentum

crashes in the recent literature. I argue that momentum crashes are due to crowded trades

which push prices away from fundamentals leading to strong reversals, and exacerbated by limits

of arbitrage being more severe in the short-leg due to impediments to short selling. Using short

interest and institutional ownership data together to measure the crowdednessof momentum,

I show that momentum crashes can be avoided in the cross section by shorting only non-crowded

losers. There is considerably more short-covering during times when momentum fails. I show

using high frequency short sale transactions data that short covering is especially severe in the

crowded loser portfolio. A placebo test using a set of 63 futures contracts show that momentum

crashes do not exist in futures market after market exposure is correctly hedged, which is

consistent with my hypothesis.

I am indebted to my adviser Harrison Hong for invaluable advice and encouragement. I am very grateful to

Jakub Jurek and David Sraer for their guidance and support. I would also like to thank Valentin Haddad, Ji Huang,

John Kim, Hyun Song Shin, Jose Scheinkman, and Wei Xiong for helpful comments and discussions. All errors are

my own.

y

Email: pyan@princeton.edu

1 Introduction

Momentum refers to a long-short investment strategy that buys past winners and sells past losers

(Jegadeesh and Titman (1993)), and its performance had been strong over the past 80 years (e.g.,

Fama and French (2008); Israel and Moskowitz (2012); Jegadeesh and Titman (2001)). In U.S.

equities, a winner minus losers long-short portfolio had an average annualized excess return of

17.52% per year, an annualized Sharpe ratio of 0.86, and earns about a 1% alpha per month

using the Fama and French (1993) three factor model.1 Compared with the U.S. market excess

return which averaged 6.42% with a Sharpe ratio of 0.43 over the same period, momentum oered

attractive returns and has been used by many quantitative and sophisticated investors. Momentum

has also been shown to exist in many other asset classes and geographic locations (e.g., Asness,

Moskowitz, and Pedersen (2013); Erb and Harvey (2006); Moskowitz, Ooi, and Pedersen (2012);

Okunev and White (2003); Rouwenhorst (1999)). The pervasiveness of momentum poses great

challenges to the e cient market hypothesis as it violates even the weakest form of market e ciency,

which posits that future prices cannot be predicted from past prices (Fama (1970)). Moreover, the

momentum anomaly is di cult to reconcile using risk-based stories (e.g., Fama and French (1996,

2008); Jegadeesh and Titman (2001)).

Despite momentums strong historical performance, its returns have large negative skewness and

experiences periods of large drawdowns referred as momentum crashes (Barroso and Santa-Clara

(2013); Daniel and Moskowitz (2013)). Figure 1 depicts two of the most notable crashes started

in July 1932 and March 2009, which had a cumulative portfolio loss of 89% and 66% respectively

over just a two month period. Other major drawdown subperiods are also plotted in Figure 1.

Overall, most of these crashes occurred at the point of market rebound preceded by periods of

market downturn.

Daniel and Moskowitz (2013) point out that most of the crashes are driven asymmetrically by

the short-leg of the strategy, occurring during market recovery following bear markets. Table 1

lists the twelve worst months for the momentum strategy as well as the one month return for the

momentum, winner, and loser portfolio. It is clear that the large negative returns experienced by

the momentum strategy are driven predominately by the losers having a much greater rebound

compared with the winners. They conclude that a conditionally high premium attached to the

option-like payo of the loser portfolio results in momentum crashes.

Several approaches had been taken in the literature aiming to explain and mitigate momentum

crashes (e.g., Barroso and Santa-Clara (2013); Daniel, Jagannathan, and Kim (2012); Daniel and

Moskowitz (2013)). The literature had focus extensively on timing the momentum factor: determin-

ing an ex-ante optimal allocation between the momentum factor and the risk-free asset. However,

little explanations have been provided as to why momentum crashes were driven asymmetrically

by the short-leg, and no economic forces and mechanisms had been documented in explaining the

optionality embedded in the past-loser portfolio.

1

Sample period used here is post WWII to the end of 2008.

1

July 1926 Dec 1934 Jan 1935 Dec 1938 Jan 1939 Dec 1940

2.5

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Momentum ($)

Momentum ($)

Momentum ($)

1.1 1.2

Market ($)

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Market ($)

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Jan 1969 Dec 1970 Jan 2000 Dec 2002 Jan 2003 Dec 2012

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Momentum ($)

Momentum ($)

Momentum ($)

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Market ($)

Market ($)

Market ($)

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Momentum Market

Month Momentum Losers Winner Month Momentum Losers Winner

1932m8 -73.32% 92.11% 18.79% 2009m4 -45.51% 45.36% -0.15%

1932m7 -59.16% 76.49% 17.33% 2001m1 -41.76% 35.52% -6.23%

1933m4 -33.85% 63.81% 29.96% 2009m3 -38.44% 43.24% 4.80%

1939m9 -32.94% 44.42% 11.48% 2009m8 -26.56% 26.75% 0.19%

1931m6 -32.41% 40.93% 8.52% 2009m5 -21.05% 23.28% 2.23%

1938m6 -32.17% 43.91% 11.74% 2002m11 -20.37% 22.79% 2.42%

2

This paper explains momentum crashes and the asymmetry in return contributions to these

crashes between the winners and losers. My hypothesis is based on two elements. First, momentum

is prone to crowded trades (Hong and Stein (1999); Stein (2009)). Excessive momentum trading

activities push prices beyond fundamental value, which lead to a re-sale of the momentum strategy

when arbitrageurs unwind upon suering losses. Second, more limits of arbitrage (Shleifer and

Vishny (1997)) in short positions compared with levered long positions amplies the re-sale eect

of the loser portfolio through short covering (Hong, Kubik, and Fishman (2012)).

Momentum is prone to crowded trades because it is a positive feedback trading strategy with

no fundamental anchor (Stein (2009)). The eects of overcrowding in momentum strategies are

described in Stein (2009) and Hong and Stein (1999) with a static and dynamic setting respec-

tively. Consider an environment where there are newswatchers representing informed traders

who underreact to fundamental information, e.g., due to slow information diusion (Hong and

Stein (1999)). If only newswatchers are present, then there is underreaction in general which gives

rise to continuation at short-horizons. The continuation in returns creates an arbitrage opportu-

nity where arbitrageurs exploit by engaging in momentum trading. Intuitively, rational arbitrageurs

should base their intensity of trading on the total arbitrage capacity. However, the uncertainty in

the amount of capital devoted to momentum trading makes it possible that arbitrageurs overcor-

rect the initial underreaction by overcrowding the momentum trade and push asset prices beyond

fundamental values. Since arbitrageurs positions are often levered, initial losses will lead to un-

winding of their positions causing a re-sale of the strategy when the arbitrageurs are late in the

momentum-cycle.

I argue that the re-sale eect for the loser stocks is stronger than that of the winners because

there are more limits of arbitrage in shorting than levered long. First, shorting is more di cult than

buying, which leads to short-sellers holding imperfectly diversied portfolios of short positions. A

short-seller rst needs to locate the shares for borrowing which may be di cult (DAvolio (2002)).

It is also di cult for short-sellers to hold on to their established positions since the lender of the

shares may recall the loan (DAvolio (2002)) or increase the lending fees (Engelberg, Reed, and

Ringgenberg (2013)) at anytime. Recalls and increases in lending fees may occur at inopportune

times forcing short sellers to liquidate short positions that wouldve been protable if they were

able to hang on to their positions. Indeed, Savor and Gamboa-Cavazos (2011) show empirically

that short sellers close out trades that are ex-post protable in response to initial losses to their

short positions. Therefore, short covering due to limits of arbitrage will amplify the initial price

increase in the loser stocks (Hong et al. (2012)), and this eect should be the strongest when market

rebounds since it is likely that a large fraction of the loser portfolio is hit by positive shocks, and

also because short-sellers are in general reluctant to bet against the market (Lamont and Stein

(2004)). Second, there is naturally more unwinding of positions in shorting compared with levered

long. This is because while an adverse price movement for a short position leads to an increase

of portfolio exposure, it decreases portfolio exposure for long positions.2 Therefore, internal risk

2

For example, suppose we establish a short position for a stock trading at $10 per share with $100 of initial capital

3

management or leverage targeting from arbitrageurs will naturally lead to more re-sale on the

short-leg when prices move in unfavorable directions.

To summarize, momentum traders lose money on their trades when momentum suers from

overcrowding. They will be forced to liquidate some of their positions since their strategy is

employed with leverage. This unwinding has an asymmetric eect on the long and short leg of the

portfolio due to more limits of arbitrage in the short-leg. The impact of short covering is further

exacerbated due to imperfect diversication of short positions and massive increases in portfolio

exposure in loser stocks facing positive shocks.

The main focus of this paper is to identify loser stocks that are subject to overcrowding by

momentum traders.3 A crowded momentum loser stock is sold heavily by both short selling arbi-

trageurs and institutions holding long positions. As such, my measure of crowding is a double sort

on short interest ratio (SIRi;t 1) and the exit rate of institutional investors (EXITi;t 1) computed

using institutional ownership data from the SEC 13F lings. The exit variable is dened as the

fraction of total shares outstanding that were completely liquidated by institutional investors in the

previous quarter. A crowded loser portfolio therefore consists of loser stocks having high SIRi;t 1

and high EXITi;t 1:

This measure is similar to the herding measure used in Lakonishok, Shleifer, and Vishny (1992).

Both measures aim to capture stocks with traders ending up on the same side of the market. My

measure of crowding diers from LSVs herding measure in two important ways. First, my measure

incorporates information in short selling, while LSVs herding measure captures only trading by

existing long investors. Since many quantitative investors engaging in momentum use short sales in

their construction of momentum portfolios, information regarding short selling is critical in gauging

the intensity of momentum trading by these investors. Second, my measure focuses only on the

level of selling by institutions, where LSV focus on net buying. As described later in Section 3.1,

following Hong and Jiang (2011), including new entries of institutions will contaminate the crowding

measure in the face of noise traders and inattentive investors.

I split the universe of loser stocks into a crowded and non-crowded portfolio using the crowd-

ing measure described above. Consistent with my hypothesis, the crowded portfolio experiences

substantial skewness and drawdown, and generally underperform the non-crowded portfolio. The

rened non-crowded momentum strategy does not suer from momentum crashes, large negative

skewness, and substantially outperform both the crowded momentum portfolio and also the base-

line portfolio. Moreover, the non-crowded loser portfolio does not display any conditional premium

during market rebound as documented by Daniel and Moskowitz (2013) for the baseline momentum

and an initial leverage of 30%. In this case, we buy 13 shares costing $130 and we have $100 in the margin account.

If the price increases by 10% to $11 per share, our margin account would be marked down to $87. The implied

leverage for this position is now ($11 13)=$87 1 = 64%. Without posting additional capital in the margin account,

we would need to cover 2.72 shares of our position to maintain a leverage of 30%. On the other hand, if we were

long 13 shares of the stock but the price drops by 10%, our margin account will be marked down the same way to

$87, but our implied leverage would only be ($9 13)=$87 1 = 34%. We would only need to sell 0.43 shares of our

long position to maintain our initial leverage.

3

I show in Section 7 that crowding exists in winner stocks as well, but with a much smaller magnitude.

4

strategy.

Evidence of crowded trades in momentum are also documented in the recent literature. Lou

and Polk (2013) identify crowded trades contemporaneously by exploiting the abnormal weekly

return correlations between individual momentum stocks and the momentum portfolio. Hanson

and Sunderam (2013) use the cross section variations in short interests to measure the level of

crowding in momentum, and show that an increase capital ow lowers the strategy return.

Using an event-time methodology similar to Hanson and Sunderam (2013), I show that loser

stocks suer from signicant abnormal short-covering during times when momentum fails. More-

over, I back out the total number of shares covered by short sellers throughout the month by

exploiting high frequency short sale transactions for all NYSE stocks from 2005-2012, and show

that the crowded loser portfolio experiences signicantly more short-covering not only during mo-

mentum crashes but also in the cross-section throughout the entire sample. I then employ hand

collected short interests data from 1931 to 1934 and show that the outcome of the large momentum

crash in 1932 is consistent with my hypothesis.

Finally, I employ a placebo test using a set of 63 futures contracts in commodities, currencies,

bonds, and indices. Consistent with my hypothesis, since there is no asymmetry between short-

ing and buying in futures markets, momentum strategies in futures markets do not suer from

momentum crashes and display no optionality once dynamic market exposure is properly hedged.

The rest of the paper is organized as follows. Section 2 describes the main data used in the

construction of the equity momentum portfolios and outlines the main testable predictions of the

paper. Section 3 describes my measure of crowded trades in momentum, and examines the per-

formance of the baseline, crowded, and non-crowded portfolios. Section 4 provides direct evidence

of short covering using high frequency NYSE TAQ Short Sales data. Section 5 documents the

event-time path of short interests and shows the unwinding of arbitragers from momentum upon

suering losses during times when momentum fails. Section 6 performs a placebo tests and re-

peats the analysis of momentum crashes in equities in futures markets. Section 7 discusses several

extensions of my empirical results. Section 8 concludes.

2 Data

The main empirical analysis for the U.S. equity market is done by combining four main datasets

described below. The full sample period for the equity data is January 1980 to September 2012.

Data on daily and monthly stock returns are from the Center of Research in Security Prices (CRSP).

Following the standard procedures for constructing the momentum portfolio, I include only common

shares (CRSP share-code 10 or 11) from all NYSE, NYSE MKT (formerly known as the AMEX),

and NASDAQ stocks.

The baseline momentum decile portfolios are constructed monthly using the past 12 months

return with NYSE breakpoints, and excluding the most recent month consistent with the literature

to avoid the one-month reversal eect. I require that the rm has a valid share price, valid number of

5

shares outstanding as of the formation date, and that there be a minimum of 8 valid monthly returns

over the past 11 months formation period. The winner and loser portfolio are then constructed as

the value-weighted portfolio of all winners and losers respectively.

Quarterly book values are obtained from COMPUSTATs total common equity. I compute

the book-to-market ratio (BMR) using the most recently available price up to one year before the

formation period as done by Asness et al. (2013).

Quarterly data on institutional holdings is obtained from the Thompson Reuters Institutional

13F Holdings. It includes all mandatory reported holdings to the SEC by money managers and

institutions with greater than $100 million of securities under discretionary management. Gompers

and Metrick (2001) contains a detailed description of this data. This data source allows us to

compute institutional exit rates (Hong and Jiang (2011)) to capture selling from institutions as one

part of my measure of crowded trades.

Monthly short interest data for NYSE, NYSE MKT, and NASDAQ stocks is obtained from

COMPUSTAT and Bloomberg. Short interest represents the total number of uncovered shares sold

short for settling on or before the 15th of each month. The short interest ratio, which is short

interest normalized by total number of shares outstanding, will be used as the second part of my

measure of crowded trades.

For the placebo test in futures markets, I employ data for a set of 63 futures contracts in com-

modities, currencies, bonds, and indices from Bloomberg. For each futures instrument, I construct

a continuous front-month excess return series following Gorton, Hayashi, and Rouwenhorst (2013)

by rolling on the 12th business day of the expiration month. The sample period for futures data is

January 1980 to June 2013.

Additional data will be discussed in the appropriate sections.

This section summarizes the main testable predictions of this paper.

Prediction 1 Momentum strategy constructed with the short-leg rened to the crowded losers is

more crash prone with larger drawdowns and more negatively skewed; momentum strategy con-

structed with the non-crowded losers should display smaller drawdowns, less negatively skewed, and

displays better performance in general.

Prediction 2 Hedging dynamic market exposure does not eliminate momentum crashes in the

crowded portfolio.

Prediction 3 After market exposure is properly hedged, the non-crowded loser portfolio is not

market state dependent and therefore displays no option-like behavior as documented by Daniel and

Moskowitz (2013) for the baseline loser portfolio.

Prediction 4 Loser stocks that are crowded su er more from short-covering than non-crowded

losers, especially during times when momentum crashes.

6

Prediction 5 (Deleveraging and Unwinding) There should be abnormal unwinding of arbitrage

capital from the momentum portfolio at a strategy level when momentum fails.

Prediction 6 (Placebo Test) Momentum in futures market should su er less from momentum

crashes, drawdowns, skewness, and market state dependency as is displayed in equities.

3.1 Measuring Crowded Trades

The objective in this section is to identify loser stocks that are crowded by momentum traders

and avoid them in the construction of the momentum strategy. Loser stocks that are crowded by

momentum traders have two characteristics: they are sold heavily by both short-sellers and also

existing share holders.

Selling activities by short-sellers are measured by the monthly short interest ratio (SIR) dened

as

short interest

Short Interest Ratio SIRit = (1)

# shares outstanding

The level of selling from existing long investors is captured by my Exit measure dened as

EXITit = (2)

# shares outstanding

The EXIT variable is measured quarterly and is dened as the total number of shares sold

by institutional investors who completely exited the market for the stock. In the beginning of

month t; if both SIRit 1 and EXITit 1 are high for a loser stock i; it means that the stock has

already undergone heavy selling both from arbitrageurs who are able to short, and also from existing

investors originally holding a long position. Stock i is therefore likely to be crowded by momentum

traders pushing price below its fundamental value, and arbitrageurs who short them run greater

risk of being late in the momentum cycle as described by Hong and Stein (1999).

The focus of this paper is to rene the short-leg of the strategy. I show in Section 7.2 that

crowding exists in the long-leg, but the magnitude is much less severe. Starting with the baseline

momentum strategy described in Section 2, I keep the long-leg of the portfolio and rene the short-

leg using SIR and EXIT: Figure 1 visualizes the construction of the double-sort this paper employs

to identify the crowded and non-crowded losers. At the beginning of month t; I classify all loser

stocks belonging to the top 20th percentile of SIRit 1 as the highly-shorted group. The loser stocks

within the highly-shorted group are then further rened based on EXITit 1: The crowded losers

are stocks that belong to the top 20th percentile of EXITit 1 within the highly-shorted group. The

remaining stocks in the highly-shorted loser group are labeled as non-crowded.

The reason for focusing only on the highly-shorted group is that a stock can have low short

interest for two reasons. Clearly, SIR will be low for stocks that have very low demand for shorting.

However, SIR can also be low due to shorting being very costly with a relatively binding short-sale

7

Non-crowded Losers Crowded

Exit by Institutions

constraint. We should expect these stocks to be more prone to short-covering if they are di cult

to short. Besides, excluding these potentially costly to short securities ensures that the portfolio

constructed here can be implemented. Moreover, a univariate sort on SIR alone shows that loser

stocks with low SIR suers severely from momentum crashes. Thus, SIR alone does not contain

enough information for us to identify crowded trades and to explain momentum crashes.

The EXIT measure only captures selling by institutions but ignore their entries. This is because

entries of institutions will contaminate my measure as explained in Hong and Jiang (2011). High

levels of entry could be capturing an increased investor base as in Merton (1987) or increased

attention from noise traders as in De Long, Shleifer, Summers, and Waldmann (1990). The frenzies

from the new investors or noise traders will induce more shorting pressure from the arbitrageurs.

Thus, high entries can be associated with more overcrowding due to the increased shorting pressure.

EXIT; on the other hand, is unlikely to suer from the same problem. This is because investors

who are already owning the stock are actively monitoring the stock.

My denition of EXIT is similar to the one used by Hong and Jiang (2011), where they dened

it as the fraction of institutions that have completely liquidated their positions the quarter prior.

Expressing it in terms of shares is more suitable for our purpose since SIR is also measured in

share terms, and that institutions with little holdings are unlikely to have major price impact.

Henceforth, the momentum portfolio that buys the baseline winners and short the crowded losers

will be referred as the crowded portfolio; and similarly the momentum portfolio constructed by

buying the baseline winners and shorting the non-crowded losers will be called the non-crowded

portfolio throughout this paper.

The stock selection method of momentum, which relies on past returns ranking, naturally induces

large time-varying market exposures (Grundy and Martin (2001)). The dynamic exposure to market

risks obscures the comparison of performance across the various strategies. Therefore, I construct

8

ex-ante market neutral portfolios that hedge the dynamic market exposure. Specically, I estimate

the market beta of individual stocks with daily return data over the past six months with ten lags

of the market return and use the sum of their coe cients as the estimate of market beta (Dimson

(1979)). At the end of month T 1 for each stock i; I run a daily time-series regression of the form:

i

r~i;t = i;T + ~tm

0;T r + i

~tm 1

1;T r + ::: + i

~tm 10

10;T r + "i;t

where r~i;t and r~tm are the excess return for stock i and the market respectively at time t:

The market beta of stock i is estimated by

^ ^i i

+ ^ 1;T + : : : + ^ 10;T

i

i;T 0;T

The ex-ante portfolio beta ^ p;T for portfolio p is then given by the value-weighted betas of indi-

vidual stocks. The hedged portfolio is formed by purchasing ^ shares of the market portfolio. p;T

h

Specically, denote r~p;t to be the portfolio excess return for month t; the hedged excess return r~p;t

is

h

r~p;t = r~p;t ^

p;T r

~m;t

This section tests Prediction 1 and Prediction 2 , and compares the portfolio performance and

characteristics for the baseline, crowded, and non-crowded momentum portfolio.

Unhedged Strategies

3

log10($ portfolio value)

0 1 1 2

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Figure 3 depicts the log cumulative return of a $1 dollar investment in Jan 1980 for the unhedged

strategies. Consistent with Prediction 1, the crowded strategy experiences signicantly larger

drawdowns compared to the uncrowded and baseline strategies. Although much of the crash is

mitigated, the non-crowded strategy still experiences moderate drawdowns.

This is due to the fact that none of these strategies are market neutral. As discussed in Grundy

and Martin (2001) and Daniel and Moskowitz (2013), in bear markets when market has fallen

signicant over the portfolio formation period, it is likely that the winners have relatively low beta

compared to that of losers. Therefore, momentum tends to overweigh on low beta stocks in the

winner portfolio, and overweighs high beta stocks in the loser portfolio. Similarly, we can expect

the opposite to happen in bull markets. This observation is conrmed in Table 2 and Table 3

where the market beta for the unhedged strategies are generally signicantly negative. The market

non-neutrality characteristics of these strategies lead to drawdowns when the market turnaround

after sustained periods of price movement in the same direction.

Hedged Strategies

3

log10($ portfolio value)

1 0 2

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Baseline

Figure 4 depicts the log cumulative return of the hedged strategies. After hedging out market

exposure, performance for all strategies improved including the baseline. Moreover, the comparison

of crashes between the crowded and non-crowded portfolios becomes more apparent. While the

drawdowns of the non-crowded portfolio are generally smaller after hedging, it did not help at all

during the 2009 crash and even displayed larger drawdown in 2000 for the baseline strategy. This

conrms Prediction 2 that time-varying market exposure is not the main driver for momentum

crashes.

Figure 5 plots the subsample log cumulative returns for the hedged non-crowded and baseline

10

Subsample Performance of Hedged Momentum Portfolios

Jan 1981 Dec 1989 Jan 1990 Dec 1999

1.5

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Jan 2000 Sep 2012 Full Sample

log10($ portfolio value)

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.2 0 .2 .4 .6

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20 1

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Ja

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Noncrowded Losers Baseline

strategies for each 10 year subperiods. The non-crowded portfolio outperformed the baseline slightly

before 2000, and substantially outperformed the baseline post 2001 even before the crash in 2009.

Given the popularity of momentum strategies among sophisticated investors and the rapid ow

of capital into hedge funds post 2001 (e.g., Wang and Zheng (2008)), the widen performance

dierential between the non-crowded portfolio with the baseline and crowded portfolio post 2001

is consistent with the crowded trade hypothesis.

Table 2 displays the portfolio statistics in the full sample for the various strategies, and quanties

the performance dierential as seen earlier in the above cumulative return gures. Consistent

with Prediction 1 and Prediction 2, the crowded portfolio displays substantial negative skewness

regardless of whether market exposure is hedged. Moreover, the non-crowded portfolio displays

superior performance with reduced skewness relative to the baseline and crowded portfolio. I

use a three year look-back window in computing the average drawdown measure.4 Since it is

misleading to compare drawdowns across strategies with substantially dierent expected returns, I

compute the return-to-drawdown ratio which is analogous to the Sharpe ratio that captures the risk-

return trade-o where risk is measured by average drawdown instead of standard deviation. The

non-crowded portfolio has the lowest absolute drawdowns and oers superior return-to-drawdown

4

Three year average drawdown is dened as follows: the month T drawdown is D(T ) =

max[0; maxs2[T 36;T ] V (T )=V (s) 1] where V (t) is the value of the portfolio at the end of month t. The

average drawdown is then the full sample average of D(T).

11

trade-os. Table 3 repeats the analysis for the post 2001 subsample and shows consistent results.

Note that the performance dierential among the non-crowded, crowded, and baseline portfolio

is much starker. The non-crowded momentum strategy continue to have modest return while the

baseline and crowded portfolios earning nearly zero and even negative returns, Sharpe ratios, and

return-to-drawdown ratio.

Daniel and Moskowitz (2013) point out that momentum crashes occur during market recovery

following bear markets, and conclude that the conditionally high premium attached to the option-

like payos of the past-loser portfolio gives rise to momentum crashes. I test Prediction 3 and ask

whether the non-crowded losers experience any of the aforementioned premium.

DM nd that the momentum portfolio is eectively a short call option on the market using the

following market-timing regression of Henriksson and Merton (1981):

~ mom;t = [

R 0 + B IB ] + 0 + IB B + IU B;U

~ mkt;t + "t

R (3)

~ mom;t and R

Here R ~ mkt;t are the excess return of the momentum strategy and market portfolio

in month t: IB is an ex-ante bear market indicator that is set to 1 when the cumulative market

return in the 24 months leading up to the start of month t is negative. IU is the contemporaneous

up market indicator that is set to 1 when market return is positive in month t. DM nd that ^ B;U

is signicantly negative, meaning that momentum is eectively a short-call option on the market.

This explains why momentum tends to crash when market rebounds in bear markets. Furthermore,

DM also show that most of the optionality comes predominately from the loser portfolio, meaning

that the estimated B;U is signicantly positive when we regress with the loser portfolio return as

dependent variable.

Prediction 3 states that most of these premium should disappear in the non-crowded loser port-

folio. I focus on the short-leg rather than the winner-minus-loser portfolio since the optionality of

momentum comes predominantly from the losers (Daniel and Moskowitz (2013)), and also because

all portfolios considered in this paper so far share the same winner portfolio. However, performing

the analysis including the long-leg does not change the conclusion. Prediction 3 states that B;U is

positive for the baseline but should be insignicant for the non-crowded loser portfolio. I replace

the dependent variable of Equation 3 and estimate the following specication

~ p;t = [

R 0 + B IB ] + 0 + IB B + IU B;U

~ mkt;t + "t

R (4)

where R

Table 4 presents the regression results for the full sample. Column (1) corresponds to the

baseline momentum strategy and reconciles the ndings of Daniel and Moskowitz (2013): the loser

portfolio is eectively a long call option on the market. The market beta in non-bear market is a

signicant ^ 0 = 1:31; the market beta in bear market with negative market return is ^ 0 + ^ B =

12

1:49; the market beta in bear market with positive market return is ^ 0 + ^ B + ^ B;U = 2:99:

The incremental beta ^ B + ^ B;U = 1:67 represents the optionality of the strategy, and an F-

test shows that its highly signicant at 1% level (last row). Column (2) corresponds to the

baseline after hedging market exposure. The market exposure is hedged as seen by the small and

insignicant ^ 0 = 0:0373: Hedging out market exposure eliminates the time-varying beta loading

eect systematic to the momentum strategy. However, the optionality remains highly signicant

even in the hedged baseline. This suggests that the embedded option in the past losers is not driven

by the time-varying beta alone.

Column (3) to (4) present the results for the non-crowded losers. Whether hedged or unhedged,

the non-crowded loser portfolio shows insignicant optionality and is therefore insensitive to market

rebound in bear markets. Indeed, the point estimate for the option coe cient of the hedged non-

crowded strategy is negative, which works in our favor if we were to short the portfolio. Table

5 repeats the analysis with the post 2001 subsample. The results are once again consistent with

our crowded trade and short covering hypothesis. This is also another test of momentum crashes:

removing the optionality is equivalent to removing the large drawdowns of momentum when the

market recovers.

This section tests Prediction 4 by inferring the amount of short covering in loser stocks and com-

paring the intensity of short covering in the crowded portfolio with the non-crowded portfolio. The

data used here is the TAQ NYSE Short Sales data which identies at a transaction level which

trades are short seller initiated for all NYSE stocks from January 2005 to September 2012. This

data allows us to compute the total volume due to short sales SVi;t 1!t throughout month t (from

end of t 1 to month t) for stock i. Together with monthly short interests SIi;t which measures

the number of uncovered shares sold short outstanding, I back out the number of shares covered

by short sellers throughout month t, Coveredi;t 1!t ; by exploiting the identity

I normalize Equation 5 by the number of shares outstanding, and dene the cover ratio CRi;t 1!t

as the fraction of total shares outstanding covered by short sellers throughout month t :

SVi;t 1!t

CRi;t 1!t = SIRi;t SIRi;t + (6)

# shares outstanding

Figure 6 plots the time-series of cross section median cover ratios for the non-crowded and

crowded loser stocks. First inspection suggests that there are no noticeable dierences between

the two series except for the spike in the cover ratio of the crowded losers in August 2009, on

which the crowded momentum portfolio has its worst return ( 131:76%) in our sample. This is

consistent with Prediction 4 that there should be more short covering among the crowded losers

13

Median Cover Ratio

25

20

Cover Ratio (%)

10 5

0 15

05

06

07

08

09

10

11

12

20

20

20

20

20

20

20

20

Noncrowded Losers Crowded Losers

Figure 6: Median fraction of total shares outstanding covered by short sellers in each

month for the crowded and non-crowded portfolio.

Next I test Prediction 4 in the cross section using Fama and MacBeth (1973) regressions. Every

month I estimate a cross section regression using the universe of loser stocks

CRi;t 1!t = it + 1t Crowdedit 1 + c1t T urnoverit 1 + c2t rit 1!t + c3t rit 2!t 1 (7)

+cBM

t

R

1BM R SIZE

it 1 + ct 1SIZE

it 1 + "it ; 8 (i; t) 2 Losers

where Crowdedit 1 is the indicator variable for stock i at time t belonging to the crowded loser

group as described in Section 3.1.5 I control for lagged turnover6 , contemporaneous and lagged

monthly return, and a full set of decile dummy controls for book-to-market ratio (BMR) and size.

The estimated coe cients for each month are then averaged to produced the nal estimates. The

standard errors are Newey and West (1987) adjusted allowing for two lags. Column (1) of Table 6

presents the results for Equation 7. The estimated ^ suggests that we should expect 0.96% of

1

total shares outstanding more short covering compared with the rest of the losers. Column (2) uses

the variations not only among the losers, but rather the full sample and asks whether our portfolio

sort as described in Figure 2 can predict more short covering in the subsequent month across the

full cross section. Specically, every month I estimate the following using the Fama and MacBeth

5

In other words, Crowdedit 1 = 1 if SIRit 1 and EXITit 1 belong to the top 20th percentile as described in Figure 2.

6

I use lagged turnover because short covering contributes to contemperaneous turnover.

14

(1973) procedure

+ 3t (HighSIRit 1 HighExitit 1) + 4t (HiExitit 1 Loserit )

+c1t T urnoverit 1 + c2t rit 1!t + c3t rit 2!t 1

+cBM

t

R

1BM

it 1

R

+ cSIZE

t 1SIZE

it 1 + cM

t

OM

1M

it

OM

+ "it

where HighSIRit and HighExitit are indicator variables for stock i belonging in the high short

interest ratio and exit group dened using the 20% cuto respectively. I also include a full set of

decile dummy control for cumulative past returns (M OM ) :

Column (2) of Table 6 shows that being highly shorted increases short covering signicantly

by 0.683% of total shares outstanding. This is consistent with the fact that short sellers have

relatively short holding horizon. Being in the high exit group alone has no signicant impact on

short covering. However, the interaction term shows that when both SIR and EXIT are high,

i.e., when the stock is more prone to overselling, short covering increases signicantly by 0.155% of

total shares outstanding. Taken together, the above results conrm Prediction 4, suggesting that

non-loser stocks are also prone to overselling and crowded trades, and further supports my choice

of SIR and EXIT as the identifying variables for crowded trades.

This section tests Prediction 5 by adopting a simple extension of Hanson and Sunderam (2013).

I trace out the event-time path of short interest ratios for stocks falling into the lowest past 12

months cumulative return decile (losers), and explores the path of short interest for loser stocks

during periods when the momentum strategy does poorly. This methodology allows us to capture

short covering at the strategy-level. Specically, I estimate the following panel specication with

stock and time xed eects

12

X 12

X

k Loser

SIRit = i+ t+ G 1it;k 1M

t;k

omentum

+ k Loser

B 1it;k 1Reversal

t;k (9)

k= 12 k= 12

size

+c 1it + cIO

size

1IO

it +c BM R BM R

1it + cexchcd 1exchcd

it

3m 30day

+c1 T urnoverit + c2 V olit + "it

it;k is set to 1 when stock i is k months away from being included

in the momentum portfolio. 1Reversal

t;k and 1M

t;k

omentum are analogous indicators for the reversal

and momentum state. A month is dened to be in reversal state if the baseline momentum

return is less than -15% during that month, and otherwise in momentum state (i.e., 1Reversal

t;k =

1 M omentum ).7 If a stock has a spellof consecutive months in the loser portfolio, the entrance

Rt;k

7

The results presented here works for a variety of reasonable cuto points.

15

and exit dummies will be measured using the rst and last month of the spell respectively. I

include both the reversal and momentum dummies for ease of presentation and interpretation of

the coe cients. 1size IO BM R are full sets of decile dummy controls for size, institutional

it ; 1it ; and 1it

ownership, and book-to-market ratio. I also include exchange xed eects (1exchcd

it ), three month

turnover, and trailing 30 days volatility as additional controls.8

1.5

Abnormal Short Interest Ratio (%)

1

.5 0

10 5 0 5 10

Event Time, Months

Reversal Momentum

Figure 7: Event time path of short interest for losers. This gure plots the event-time

path of SR for stocks entering the momentum loser decile. Regression coe cients ^ kG and ^ kB esti-

mated from Equation 9 are plotted against k for the momentum and reversal state respectively. A

month is in reversalif the baseline momentum return is less than -15%, and otherwise in momen-

tum state. I draw 95% condence bands around these estimates using standard errors clustering

by both stock and month as done by Thompson (2011). Nobs = 1; 282; 784; T = 390; Nstocks =

2

14; 644; RN F E = 37%.

Figure 7 traces out the event-time path of short interest ratios for stocks entering the loser

portfolio by plotting ^ kG and ^ kB against k. Hanson and Sunderam (2013) argue that the estimated

^ ki represents ow of arbitrage capital into the momentum strategy on average. Thus, we can

interpret the gure as the event-time path of arbitrage capital ow into the momentum strategies

prior and post portfolio formation. The 95% condence bands are plotted around the estimates

using standard errors clustered both at the stock and month level as done by (Thompson (2011)).

In both states, short interest gradually builds up over months before the stock enters the loser

8

These are standard known determinants of short ratios, see DAvolio (2002); Hanson and Sunderam (2013).

16

decile and sharply closes out as the stock exits the loser decile.9

Prior to entering the loser decile (before time 0), abnormal short interest is higher in reversal

states than in momentum states consistently by about 50bps. Thus there is more capital devoted

to momentum prior to the reversal state. However, the decline in SIR when the stock exits the loser

decile is sharper for reversal states than for momentum states. An F-test shows that the dierence

is a highly signicant 35bps with an F-stat of 10.98. This dierence is also highly economically

signicant given that the peak abnormal SIR for the momentum state is only 42bps. Hence, during

reversal times, the demand for shorting losers is higher and short-covering is more severe coming

out of the loser portfolio.

Taken together, more capital is devoted to momentum strategy prior to its failure is consistent

with Prediction 1 that the strategy is likely crowded prior to its failure. Moreover, it conrms

Prediction 5 that arbitrageurs do unwind from momentum upon suering losses in the reversal

state which causes loser stocks to suer more from short covering when momentum fails.

To validate our EXIT measure, we need to conrm that there is indeed more selling from insti-

tutions prior to momentum crashes. Using the same framework as above, I show that the decline

in institutional ownership (IO) over the same period is 67% higher in reversal states. To formally

illustrate this point, rst I dene Institutional Ownership (IO) as

Institutional Ownership IO = (10)

# shares outstanding

I then estimate a panel specication with stock and time xed eects:

12

X 12

X

k Loser

IOit = i + t + G 1it;k 1M

t;k

omentum

+ k Loser

B 1it;k 1Reversal

t;k (11)

k= 12 k= 12

size

1BM

it

R

+ cexchcd 1exchcd

it

3m 30day

+c1 T urnoverit + c2 V olit + "it

Figure 8 depicts the event-time path of IO for loser stocks entering into the lowest momentum

decile. Throughout the twelve months prior to entering the loser decile, losers have a change in

0 12

IO ^i ^i of 2:90% and 4:84% for the momentum and reversal state respectively. The

dierence of decline in IO between momentum and reversal states of 1.94% is economically and

statistically signicant (F-stat=7.62).

To summarize, the decline in IO during reversals are 67% higher than that in momentum

states. There is substantial selling of the loser stocks from institutional investors prior to the

9

Since momentum works over shorter horizon (e.g., Jegadeesh and Titman (1993)), the gradual build up of the SR

can be explained by arbitrageurs playing momentum over dierent horizons.

17

6

Abnormal Institutional Ownership (%)

2 0 2 4

4

10 5 0 5 10

Event Time, Months

Reversal Momentum

Figure 8: Event time path of institutional ownership for losers. This gure plots the

event-time path of IO for stocks entering the momentum loser decile. Regression coe cients

^k and ^k estimated from Equation 11 are plotted against k for the momentum and rever-

G B

sal state respectively. A month is in reversal if the baseline momentum return is less than

-15%, and otherwise in momentum state. I draw 95% condence bands around these esti-

mates using standard errors clustering by both stock and month as done by Thompson (2011).

2

Nobs = 1; 436; 344; T = 390; Nstocks = 15; 494; RN F E = 23%. The number of observations diers

from Figure 7 due to missing short interest data for some stocks. Restricting the estimation to a

common sample gives almost identical results.

18

failure of momentum. This suggests that institutions trade in a momentum fashion at least within

the losers, and overcrowding momentum together with high inow of short selling capital leading

to the failure of momentum. In fact, in unreported analysis, there is substantial decrease in IO

just prior to momentum crashes, with the sharpest decrease in SIR being the momentum crashing

month.10

Hedging the time-varying market exposures is not su cient in eliminating momentum crashes,

drawdowns, skewness, and the embedded optionality in U.S. equity momentum. However, since

there is no asymmetry between buying and shorting in futures market, a market neutral momen-

tum strategy in futures market should not be prone to crashes according to our initial hypothesis

regarding crowded trades and limits of arbitrage in shorting. This section test Prediction 6 using

a set of 63 futures contracts in commodities, currencies, bonds, and indices.

I analyze a set of 28 commodity futures, 6 bond futures, 10 currency futures, and 19 index

futures, a total of 63 futures contracts obtained from Bloomberg. The full sample period used for

the futures market is January 1981 to June 2013. Table 12 summarizes the futures contracts used

in dierent markets.

Due to the small number of contracts in the non-commodity markets, I report the results for

all asset classes, the commodities only strategy, and the non-commodity strategy. I follow Asness

et al. (2013) in constructing the futures momentum strategy, and the market portfolio is dened as

the equal-weighted portfolio within the respective group. Let Ri;t be the cumulative t 2 to t 12

returns for futures contract i: I assign weights

P

i rank (Ri;t )

wi;t = ct rank (Ri;t )

N

where ct is chosen such that the portfolio is dollar-neutral. The use of this weighting scheme is

because doing a decile sort will leave too small of a cross-section. Constructing the portfolio using

quintile and tercile sorts produce qualitatively identical results.

Table 7 presents the performance statistics of momentum in futures markets. Futures momen-

tum displays comparable (if not better) average return, volatility and Sharpe ratios. However, the

hedged futures strategy has a signicantly better skewness of positive 1.27 compared to the hedged

baseline in equity of negative -0.88. Figure 9(a) and Figure 9(b) plot the log cumulative returns

for the unhedged and hedged strategies respectively. Although there are some down-runs early

in the sample in the commodity strategy, overall there are no crashes and the magnitude of the

drawdowns are much smaller compared with equities. The return-to-drawdown ratio in futures is

50% higher than that in equities. Since there are very few commodities traded early in the sample,

the drawdowns are presumably due to the ineectiveness of cross-section momentum investing with

10

I test this by adding additional event-dummy variables which corresponds to the worst-upward-movement during

the continuous loser spell interacted with 1Reversal

t and 1M

t

omentum

into Equation 9 and Equation 11.

19

Cumulative Returns Unhedged Futures

1.5

1

log10($ value)

.5 0

80

82

84

86

88

90

92

94

96

98

00

02

04

06

08

10

12

14

19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

20

20

20

(a) Unhedged Futures Momentum

2 1.5

log10($ value)

1 .5

0

80

82

84

86

88

90

92

94

96

98

00

02

04

06

08

10

12

14

19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

20

20

20

NonCommodities

Figure 9: Cumulative log returns for momentum portfolios in futures markets. Figure

(a) and (b) correspond to the unhedged and hedged strategy respectively. Hedged strategies refer to

the elimination of market exposure due to holdings as described in Section 3.2. The All Futures

strategy is formed by including comodity, bond, currency, and index futures; Commodity strat-

egy includes commodity futures only; and Non-commodity includes all futures contracts except

commodities.

20

a small cross-section due to imperfect diversication. Once we expand the sample by including all

futures contract in the early sample, the drawdowns no longer exist. The fact that momentum

strategies in futures market do not suer the same skewness, drawdown, and crash problems as

in equities is consistent with my hypothesis that these problems are a by-product more limits of

arbitrage in shorting.

We should expect that any optionality embedded in momentum portfolio formed in futures markets

be eliminated after time-varying market exposure is correctly accounted for. This section performs

similar analysis as Section 3.4 in futures markets. I use daily data in the past 6 months to estimate

the market beta of the portfolio and to construct the hedging portfolio as described in Section 3.2.

Table 8 tests whether the various momentum strategies in futures market has signicant optionality

embedded. Column (1), (3), (5) represent the strategies not accounting for time-varying market

exposure due to change in holdings. All three strategies display both economically and statistically

signicant negative coe cient in ^ B;U and ^ B;U + ^ B : The unhedged All Futuresstrategys beta

is ^ + ^ = 1:92 lower during rebound months in bear markets. The magnitude displayed

B;U B

here for momentum in futures market is comparable to that of equities. My results here conformed

with Daniel and Moskowitz (2013).

However, column (2), (4), and (6) show that none of the futures momentum strategies display

any signicant optionality once the time-varying market exposure due to portfolio holdings is ac-

counted for. This suggests that the optionality displayed in futures momentum is driven solely by

the portfolio weights tilting towards low (high) beta contracts in the long (short) leg during bear

markets. Table 9 repeats the analysis in the post 2001 subsample and gives qualitatively identical

results. My ndings are once again supportive of my hypothesis that the optionality of momentum

is driven by more limits of arbitrage in the short-leg.

7 Extensions

7.1 Momentum Crashes of Loser Stocks in 1932

The sample period of the main analysis done in this paper starts from January 1980 as its the

rst available date for the Thompson Reuters Institution 13F holdings. NYSE published a book in

1951 with monthly short interest data starting May 1931 for 24 selected stocks. This data allows

us to examine path of short interests of loser stocks during the momentum crash in 1932. Among

the 24 selected stocks, 10 of them belonged to the bottom 30% of the past year cumulative return

distribution (losers).

Figure 10 plots the average short interests ratio together with the total value of the loser

portfolio. The red vertical line is the date at which the momentum crash occurred. Consistent with

the crowded trade hypothesis, we see that the prices of loser stocks were likely below fundamental

and thus reverts back subsequently towards the end of 1933. However, the path of short interest

21

14 1.6

12 1.4

1.2

10

1

8

0.8

6

0.6

4

0.4

2 0.2

0 0

Aug-30 Mar-31 Oct-31 Apr-32 Nov-32 May-33 Dec-33 Jun-34

Figure 10: Average Short Interest Ratio of Selected Loser Stocks in 1932

ratio is quite dierent from what is documented with the post 1980 data. Short interests were

highest at the peak of the loser portfolio value in May 1931, and short sellers were covering their

positions as price starts to fall. Short sellers have covered a majority of their positions before the

rebound occurred. This is consistent with the general belief that short sellers were informed back

in the 1930s since only very sophisticated investors establish short positions.

This paper has focused on identifying crowded trades in the loser portfolio. We can dene a notion

of crowded winners in an analogous way as in Section 3.1. Figure 11 visualizes the construction

of the crowded and non-crowded winner portfolio, and I will again use 20th percentile breakpoints.

The rationale for using EXIT rather, say, EN T RY here is along the same line as before: inows

of institutions contaminate our measure in the face of investor inattention or noise traders (Hong

and Jiang (2011)).

Figure 12 plots the cumulative log returns of hedged crowded winners, hedged non-crowded

winners, and the market portfolio. First, the crowded strategy is more volatile and experiences

larger drawdowns and crashes. The post 2001 performance of the crowded winners strategy is

trending downwards, consistent with the rise of hedge funds likely overcrowding momentum. Note

also that the crowded strategy seems to be sensitive to market state in the opposite fashion com-

pared with the losers: the crowded winners portfolio crashes when market retreats in bull market.

The non-crowded portfolio, on the other hand, does not suer from these problems.

I formally test the optionality in bull market for the winner portfolios. Table 10 presents the

regressions analogous to what is done in Section 3.4 on the winner portfolios. Consistent with

the crowded trade hypothesis, the crowded winner portfolio is essentially long a put option on

22

Short Interest Ratio

Exit by Institutions

Figure 11: Splitting the winners into a crowded and non-crowded portfolio

.8

1 .8

.6

log10($ portfolio value)

.6

.4

lcummkt

.4

.2

.2

0

0

.2

80

82

84

86

88

90

92

94

96

98

00

02

04

06

08

10

12

19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

20

20

Market

23

the market during bull markets: both the hedged and unhedged crowded winner portfolio displays

signicant positive estimates of ^ ; meaning that the loser stocks will fall when the market retreats

L;D

from a bull market. The non-crowded portfolios again do not suer from the same problem whether

hedged or unhedged. However, contrary to previous analysis, the baseline winner portfolio does not

display signicant optionality. This is consistent with our hypothesis that the optionality comes

from the interaction of crowded trades and the di culty of shorting. Since the construction of the

winners portfolio does not involve shorting, it is harder to detect such optionality. Table 11 repeats

the analysis using the post 2001 subsample. None of the winner portfolios displays signicant

optionality, but the signs of the crowded portfolios are consistent with the presence of optionality

that is adverse to the performance of the momentum strategy.

8 Conclusion

I show that momentum crashes are due to overcrowding of momentum together with more limits

of arbitrage on the short-leg of the strategy. The loser portfolio is classied into a crowded and

non-crowded loser portfolio based on institutional exit rates and short interest ratio. Rening mo-

mentum to the non-crowded losers improves the performance of momentum signicantly, eliminates

momentum crashes, with improved return-to-drawdown trade-os and smaller negative skewness.

Moreover, there is considerable short-covering in the crowded losers especially during times when

momentum crashes. I show that arbitrageurs unwinds from the momentum strategy upon suering

losses when momentum fails. The embedded optionality in the loser portfolio as documented by

Daniel and Moskowitz (2013) is explained by a crowded trade and short covering mechanism, and

the optionality is eliminated once the momentum strategy is rened to the non-crowded losers.

Finally, placebo tests using a set of 63 futures contracts in commodities, currencies, bonds, and in-

dices support my hypothesis that impediments in shorting are important in explaining momentum

crashes.

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26

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27

Table 2: Strategy Statistics Full Sample

Hedged Hedged

Mean 12.63% 16.17% 16.38% 22.08% 22.15% 24.83%

Std. Dev. 26.31% 22.56% 44.62% 42.54% 30.66% 28.01%

Sharpe Ratio 0.48 0.72 0.37 0.52 0.72 0.89

Return-to-Drawdown Ratio 0.67 1.01 0.55 0.81 1.28 1.88

Three Year Avg Drawdown 18.95% 15.95% 29.98% 27.23% 17.34% 13.22%

Skewness -1.61 -0.88 -3.81 -3.60 -0.91 -0.62

Kurtosis 11.13 7.91 40.02 39.98 6.73 5.27

Min -45.51% -35.36% -138.86% -131.76% -41.58% -29.77%

28

FF3-Alpha 18.37% 18.45% 25.62% 27.43% 26.70% 25.79%

t-stat FF3-Alpha 4.43 4.31 4.10 4.51 5.72 5.25

Market Beta -0.47 -0.06 -0.64 -0.02 -0.42 0.16

t-stat Beta -3.10 -0.48 -3.71 -0.11 -3.13 1.33

Notes: The sample period is Jan 1981 to Sep 2012. The denitions for the dierent strategies are described in Section 3.1. Means,

standard deviations, Sharpe ratios, and FF3-Alphas are annualized. Three year average drawdown is dened as follows: the month T

drawdown is D(T ) = max[0; maxs2[T 36;T ] V (T )=V (s) 1] where V (t) is the value of the portfolio at the end of month t. The average

drawdown is then the full sample average of D(T). The return-to-drawdown ratio is the ratio between annualized excess portfolio return

and three year average drawdown. The minimum and maximum returns are one month return and are not annualized. FF-3 Alphas

and Market Betas are calculated using the Fama and French (1993) three factor model estimated with monthly data. The t-stats are

estimated using OLS with Newey and West (1987) standard errors with two lags.

Table 3: Strategy Statistics Post 2001

Hedged Hedged

Mean 1.06% 1.07% -1.88% -1.27% 14.82% 15.42%

Std. Dev. 34.49% 26.29% 58.94% 52.50% 40.43% 32.59%

Sharpe Ratio 0.03 0.04 -0.03 -0.02 0.37 0.47

Return-to-Drawdown Ratio 0.03 0.03 -0.04 -0.03 0.43 0.63

Three Year Avg Drawdown 36.40% 31.06% 53.05% 45.12% 34.54% 24.57%

Skewness -1.77 -1.33 -4.19 -4.99 -0.84 -0.80

Kurtosis 8.55 8.17 33.56 42.67 5.15 5.11

Min -45.51% -35.36% -138.86% -131.76% -41.58% -29.77%

29

FF3-Alpha 2.47% 1.70% 8.17% 8.89% 18.42% 19.03%

t-stat FF3-Alpha 0.31 0.22 0.60 0.74 1.97 2.23

Market Beta -1.08 -0.24 -1.07 -0.16 -0.92 0.17

t-stat Beta -4.19 -1.30 -3.67 -0.80 -3.26 0.96

Notes: This is a replication of Table 2 with subsample from Jan 2001 to Sep 2012. The denitions for the dierent strategies are

described in Section 3.1. Means, standard deviations, Sharpe ratios, and FF3-Alphas are annualized. Three year average drawdown is

dened as follows: the month T drawdown is D(T ) = max[0; maxs2[T 36;T ] V (T )=V (s) 1] where V (t) is the value of the portfolio at

the end of month t. The average drawdown is then the full sample average of D(T). The return-to-drawdown ratio is the ratio between

annualized excess portfolio return and three year average drawdown. The minimum and maximum returns are one month return and

are not annualized. FF-3 Alphas and Market Betas are calculated using the Fama and French (1993) three factor model estimated with

monthly data. The t-stats are estimated using OLS with Newey and West (1987) standard errors with two lags.

Table 4: Loser Portfolio Optionality Regressions Full Sample

(1) (2) (3) (4)

Baseline Baseline Hedged Non-crowded Non-crowded Hedged

^B -0.0176 -0.0132 -0.00684 0.0198

(-1.136) (-0.982) (-0.295) (1.030)

^ 1.309*** -0.0373 1.473*** -0.0635

0

(16.92) (-0.551) (13.28) (-0.491)

^ 0.183 -0.296 0.165 0.0345

B

(0.817) (-1.396) (0.362) (0.103)

^ 1.488** 1.218** 1.016 -0.109

B;U

(2.091) (1.973) (1.191) (-0.173)

^0 -0.00380 -0.00492** -0.0124*** -0.0158***

(-1.470) (-1.972) (-3.202) (-4.076)

30

^ +^ 1.670 0.922 1.181 -0.0745

B B;U

p-value 0.00456 0.0603 0.0306 0.867

~ p;t = [

R 0 + B IB ] +[ 0 + IB ( B + IU ~

B;U )]Rmkt;t + et

with the dependent variable being the return of the baseline and non-crowded loser portfolios. IB is an ex-ante bear market indicator

that is set to 1 when the cumulative market return in the 24 months leading up to the start of the month t is negative. IU is the

contemperaneous up market indicator that is set to 1 when the market return is positive in month t. The p-value comes from an F-test

of the null hypothesis that ^ B + ^ B;U = 0. The t-statistics (shown in parenthesis) are adjusted using the Newey and West (1987)

estimator with 2 lags. Monthly regression from Jan 1980 to Sep 2012. t-statistics are shown in parentheses. *, **, and *** means that

the point estimate is statistically dierent from zero at 10%, 5% and 1% level of signicance.

Table 5: Loser Portfolio Optionality Regressions Post 2001

Baseline Baseline Hedged Non-crowded Non-crowded Hedged

^B -0.0150 -0.0141 -2.42e-06 0.0222

(-0.921) (-0.970) (-9.75e-05) (1.082)

^ 1.776*** 0.188 1.908*** 0.0640

0

(11.40) (1.209) (5.573) (0.258)

^ -0.284 -0.521** -0.270 -0.0930

B

(-1.066) (-2.030) (-0.509) (-0.228)

^ 1.488** 1.218* 1.016 -0.109

B;U

(2.067) (1.950) (1.178) (-0.171)

^0 -0.00637 -0.00406 -0.0193** -0.0182**

(-1.251) (-0.728) (-2.381) (-2.312)

31

^ +^ 1.203 0.697 0.746 -0.202

B B;U

p-value 0.0488 0.177 0.251 0.683

~ p;t = [

R 0 + B IB ] +[ 0 + IB ( B + IU ~

B;U )]Rmkt;t + et

with the dependent variable being the return of the baseline and non-crowded loser portfolios. IB is an ex-ante bear market indicator

that is set to 1 when the cumulative market return in the 24 months leading up to the start of the month t is negative. IU is the

contemperaneous up market indicator that is set to 1 when the market return is positive in month t. The p-value comes from an F-test

of the null hypothesis that ^ B + ^ B;U = 0. The t-statistics (shown in parenthesis) are adjusted using the Newey and West (1987)

estimator with 2 lags. Monthly regression from Jan 2001 to Sep 2012. The results for the full sample regressions is in Table 4.

t-statistics are shown in parentheses. *, **, and *** means that the point estimate is statistically dierent from zero at 10%, 5% and

1% level of signicance.

Table 6: Cover Ratio Fama-Macbeth Regressions

(1) (2)

Cover Ratio Cover Ratio

(2.246)

High Short Interest Ratio[t-1] 0.683***

(12.94)

High Exit[t-1] -0.0219

(-0.825)

High SIR x High Exit[t-1] 0.155***

(4.617)

Constant 0.0903 -0.206

(0.464) (-0.183)

Book-to-Market Ratio Decile Control Yes Yes

Momentum Decile Control No Yes

Losers Only Subsample Yes No

Observations 5,859 97,279

Average R2 0.726 0.634

Number of Months 93 93

Note: Fama and MacBeth (1973) estimation with Newey and West (1987) adjusted standard

errors allowing for 2 lags. t-statistics are shown in parentheses. *, **, and *** means that the

point estimate is statistically dierent from zero at 10%, 5% and 1% level of signicance.

32

Table 7: Mometum in Futues Markets Strategy Statistics

No Hedging Hedged Market Risk

All Futures Commodity Non-commodity All Futures Commodity Non-commodity

Mean 10.53% 5.48% 8.00% 12.40% 12.60% 9.10%

Std. Dev. 19.23% 18.06% 15.76% 17.13% 19.96% 16.54%

Sharpe Ratio 0.55 0.30 0.51 0.72 0.63 0.55

Return-to-Drawdown Ratio 1.12 0.56 0.97 1.95 1.63 1.29

Three Year Avg Drawdown 9.42% 9.72% 8.25% 6.36% 7.75% 7.06%

Skewness 0.88 0.19 0.21 1.27 -0.07 0.79

Kurtosis 9.45 3.56 3.81 9.64 3.57 6.09

Min -15.78% -14.62% -10.77% -12.86% -17.84% -12.61%

Max 37.65% 18.27% 13.64% 27.20% 17.29% 20.23%

Panel B: Post 2001

No Hedging Hedged Market Risk

33

Mean 5.68% 5.48% 8.00% 12.40% 12.60% 9.10%

Std. Dev. 14.58% 18.06% 15.76% 17.13% 19.96% 16.54%

Sharpe Ratio 0.39 0.30 0.51 0.72 0.63 0.55

Return-to-Drawdown Ratio 0.82 0.56 0.97 1.95 1.63 1.29

Three Year Avg Drawdown 6.95% 9.72% 8.25% 6.36% 7.75% 7.06%

Skewness 0.09 0.19 0.21 1.27 -0.07 0.79

Kurtosis 3.85 3.56 3.81 9.64 3.57 6.09

Min -12.13% -14.62% -10.77% -12.86% -17.84% -12.61%

Max 13.81% 18.27% 13.64% 27.20% 17.29% 20.23%

Notes: The All Futures strategy is formed by including comodity, bond, currency, and index futures; Commodity strategy includes

commodity futures only; and Non-commodity includes all futures contracts except commodities. Means, standard deviations, and

sharpe ratios are annualized. Market risk is hedged as described in Section 3.2, with market index constructed as an equal-weighted

portfolio within the group. Three year average drawdown is dened as follows: the month T drawdown is

D(T ) = max[0; maxs2[T 36;T ] V (T )=V (s) 1] where V (t) is the value of the portfolio at the end of month t. The average drawdown is

then the full sample average of D(T). The return-to-drawdown ratio is the ratio between annualized excess portfolio return and three

year average drawdown. The minimum and maximum returns are one month returns and are not annualized.

Table 8: Futures Momentum Optionality Regressions Full Sample

All Futures All Futures Commodity Commodity Non-commodity Non-commodity

Hedged Hedged Hedged

^B 0.0225*** 0.0108 0.0265*** 0.00996 0.0207** 0.0138

(2.596) (1.195) (2.667) (0.938) (2.059) (1.426)

^ 0.454*** -0.539** 0.427*** -0.0390 0.291** -0.0566

0

(2.878) (-2.305) (3.134) (-0.301) (2.002) (-0.319)

^ -0.206 0.641 0.158 -0.0844 -1.243*** -1.198**

B

(-0.505) (1.445) (0.414) (-0.200) (-3.710) (-2.430)

^ -1.712*** -0.610 -1.642*** -0.403 -0.0658 0.665

B;U

(-2.985) (-0.920) (-2.792) (-0.633) (-0.0991) (0.992)

^0 0.00824** 0.0118*** 0.00907** 0.0124*** 0.000309 0.00252

(2.433) (3.364) (2.172) (2.774) (0.135) (1.006)

34

^ +^ -1.919 0.0312 -1.483 -0.488 -1.309 -0.533

B B;U

p-value < 0:001 0.947 < 0:001 0.187 0.0192 0.235

~ p;t = [

R 0 + B IB ] + [ + IB ( B + IU ~

B;U )]Rmkt;t + et

with the dependent variable being the return of the momentum portfolio formed in futures markets. The All Futures strategy is

formed by including comodity, bond, currency, and index futures; Commodity strategy includes commodity futures only; and

Non-commodity includes all futures contracts except commodities. Market index is dened as the equal-weighted portfolio within the

respective group. IB is an ex-ante bear market indicator that is set to 1 when the cumulative market return in the 24 months leading

up to the start of the month t is negative. IU is the contemperaneous up market indicator that is set to 1 when the market return is

positive in month t. The p-value comes from an F-test of the null hypothesis that ^ B + ^ B;U = 0. The t-statistics (shown in

parenthesis) are adjusted using the Newey and West (1987) estimator with 2 lags. Monthly regression from Jan 1980 to Sep 2012.

t-statistics are shown in parentheses. *, **, and *** means that the point estimate is statistically dierent from zero at 10%, 5% and

1% level of signicance.

Table 9: Futures Momentum Optionality Regressions Post 2001

All Futures All Futures Commodity Commodity Non-commodity Non-commodity

Hedged Hedged Hedged

^B 0.0317*** 0.0146 0.0307*** 0.00599 0.0197* 0.0111

(2.656) (1.091) (2.749) (0.405) (1.855) (1.023)

^ 0.412*** -0.734** 0.334*** -0.167 0.0632 -0.361

0

(2.954) (-2.057) (3.490) (-1.346) (0.188) (-0.954)

^ 0.105 1.156* 0.623* 0.135 -0.991** -0.922

B

(0.166) (1.909) (1.852) (0.242) (-2.279) (-1.625)

^ -1.722** -0.764 -1.958*** -0.500 -0.536 0.349

B;U

(-2.119) (-0.929) (-3.811) (-0.573) (-0.807) (0.477)

^0 0.00137 0.0108** 0.00333 0.0122** 0.00284 0.00425

(0.424) (1.989) (0.710) (2.140) (0.692) (0.945)

35

^ +^ -1.617 0.393 -1.335 -0.365 -1.527 -0.573

B B;U

p-value < 0:001 0.502 < 0:001 0.464 0.0214 0.361

~ p;t = [

R 0 + B IB ] + [ + IB ( B + IU ~

B;U )]Rmkt;t + et

with the dependent variable being the return of the momentum portfolio formed in futures markets. The All Futures strategy is

formed by including comodity, bond, currency, and index futures; Commodity strategy includes commodity futures only; and

Non-commodity includes all futures contracts except commodities. Market index is dened as the equal-weighted portfolio within the

respective group. IB is an ex-ante bear market indicator that is set to 1 when the cumulative market return in the 24 months leading

up to the start of the month t is negative. IU is the contemperaneous up market indicator that is set to 1 when the market return is

positive in month t. The p-value comes from an F-test of the null hypothesis that ^ B + ^ B;U = 0. The t-statistics (shown in

parenthesis) are adjusted using the Newey and West (1987) estimator with 2 lags. Monthly regression from Jan 2001 to June 2013. The

results for the full sample regressions is in Table 8. t-statistics are shown in parentheses. *, **, and *** means that the point estimate

is statistically dierent from zero at 10%, 5% and 1% level of signicance.

Table 10: Winner Portfolio Optionality Regressions Full Sample

(1) (2) (3) (4) (5) (6)

Baseline Baseline Hedged Crowded Non-crowded Crowded Hedged Non-crowded

Hedged

^L 0.00111 0.00214 0.00763 -0.00479 0.00862 -0.00429

(0.226) (0.511) (0.685) (-0.772) (0.752) (-0.664)

^ 0.850*** -0.0371 0.653*** 0.807*** -0.191* -0.00154

0

(8.969) (-0.563) (4.784) (7.980) (-1.688) (-0.0170)

^ 0.377*** 0.126 0.146 0.173 -0.0697 0.000953

L

(2.922) (1.209) (0.746) (1.240) (-0.399) (0.00668)

^ 0.107 0.0129 0.438** 0.218 0.515** 0.138

L;D

(0.654) (0.0958) (2.093) (1.373) (2.373) (0.631)

^0 0.00252 0.000812 0.00537 0.0123** 0.00496 0.0111**

36

R-squared 0.733 0.0159 0.317 0.596 0.0146 0.0100

^ +^ 0.484 0.138 0.585 0.391 0.445 0.139

L L;D

p-value 0.000751 0.185 0.00109 0.00434 0.0105 0.403

~ p;t = [

R 0 + L IL ] +[ 0 + IL ( L + ID ~

L;D )]Rmkt;t + et

with the dependent variable being the return of the baseline, crowded, and non-crowded winner portfolios. IL is an ex-ante bull market

indicator that is set to 1 when the cumulative market return in the 24 months leading up to the start of the month t is positive. ID is

the contemperaneous down market indicator that is set to 1 when the market return is negative in month t. The p-value comes from an

F-test of the null hypothesis that ^ L + ^ L;D = 0. The t-statistics (shown in parenthesis) are adjusted using the Newey and West (1987)

estimator with 2 lags. Monthly regression from Jan 1980 to Sep 2012. t-statistics are shown in parentheses. *, **, and *** means that

the point estimate is statistically dierent from zero at 10%, 5% and 1% level of signicance.

Table 11: Winner Portfolio Optionality Regressions Post 2001

(1) (2) (3) (4) (5) (6)

Baseline Baseline Hedged Crowded Non-crowded Crowded Hedged Non-crowded

Hedged

^L -0.00309 -0.00129 -0.00546 -0.0129 -0.00358 -0.0128

(-0.408) (-0.177) (-0.404) (-1.446) (-0.255) (-1.498)

^ 0.850*** -0.0371 0.653*** 0.807*** -0.191* -0.00154

0

(8.867) (-0.557) (4.729) (7.889) (-1.669) (-0.0168)

^ 0.405* 0.0187 0.244 0.391* -0.185 0.0237

L

(1.858) (0.0886) (0.775) (1.724) (-0.531) (0.108)

^ -0.123 -0.0856 0.0585 -0.110 0.326 -0.155

L;D

(-0.283) (-0.195) (0.127) (-0.233) (0.571) (-0.370)

^0 0.00252 0.000812 0.00537 0.0123** 0.00496 0.0111**

(0.622) (0.243) (0.533) (2.316) (0.477) (2.136)

37

^ +^ 0.283 -0.0669 0.302 0.281 0.141 -0.132

L L;D

p-value 0.370 0.827 0.333 0.428 0.701 0.670

~ p;t = [

R 0 + L IL ] +[ 0 + IL ( L + ID ~

L;D )]Rmkt;t + et

with the dependent variable being the return of the baseline, crowded, and non-crowded winner portfolios. IL is an ex-ante bull market

indicator that is set to 1 when the cumulative market return in the 24 months leading up to the start of the month t is positive. ID is

the contemperaneous down market indicator that is set to 1 when the market return is negative in month t. The p-value comes from an

F-test of the null hypothesis that ^ L + ^ L;D = 0. The t-statistics (shown in parenthesis) are adjusted using the Newey and West (1987)

estimator with 2 lags. Monthly regression from Jan 2001 to Sep 2012. The results for the full sample regressions is in Table 10.

t-statistics are shown in parentheses. *, **, and *** means that the point estimate is statistically dierent from zero at 10%, 5% and

1% level of signicance.

Table 12: Futures Contracts Descriptions. The 63 futures contracts used in the paper are

listed here. They are traded on Chicago Board of Trade (CBOT), the Intercontinental Exchange

(ICE), Chicago Mercantile Exchange (CME), and the New York Mercantile Exchange (NYMEX).

Commodity Corn CBT Jan 1980

Commodity Cocoa ICE Jan 1980

Commodity Crude Oil, WTI NYMEX Mar 1983

Commodity Crude Oil, Brent ICE Jun 1988

Commodity Cotton, No. 2 ICE Jan 1980

Commodity Milk CME Jan 1996

Commodity Ethanol, CME Futures CBT Jan 2001

Commodity Cattle, Feeder CME Jan 1980

Commodity Gold, 100 oz NYMEX Jan 1980

Commodity Copper NYMEX Feb 1988

Commodity NY Harbor ULSD (Heating Oil) NYMEX Jul 1986

Commodity Coee, C ICE Jan 1980

Commodity Lumber CME Apr 1986

Commodity Cattle, Live CME Jan 1980

Commodity Lean Hogs CME Apr 1986

Commodity Natural Gas NYMEX Apr 1990

Commodity Oats CBT Jan 1980

Commodity Palladium NYMEX Apr 1986

Commodity Platinum NYMEX Apr 1986

Commodity Gasoil ICE Jul 1989

Commodity Rice, Rough CBT Feb 1988

Commodity Soybean CBT Jan 1980

Commodity Sugar, #11 World ICE Jan 1980

Commodity Silver NYMEX Jan 1980

Commodity Soybean Meal CBT Jan 1980

Commodity Wheat CBT Jan 1980

Commodity Gasoline, RBOB NYMEX Jan 2001

Bond Eurodollar, 3Mo CME Apr 1986

Bond US Treasury Note, 5Yr CBT May 1988

Bond US Treasury Note, 2Yr CBT Jun 1990

Bond US Treasury Note, 10Yr CBT May 1982

Bond US Treasury Long Bond CBT Jan 1980

Bond US Treasury Ultra Bond CBT Jan 2010

38

Table 12 (continued)

Market Description Exchange First Observation

Currency JPY/USD Future CME May 1986

Currency NZD/USD Future CME May 1997

Currency MXN/USD Future CME Apr 1995

Currency RUB/USD Future CME Apr 1998

Currency CHF/USD Future CME Apr 1986

Currency AUD/USD Future CME Jan 1987

Currency GBP/USD Future CME May 1986

Currency BRL/USD Future CME Jan 1995

Currency CAD/USD Future CME Apr 1986

Index DJ US Real Estate CBT Feb 2007

Index DJ Industrial Average Mini CBT Apr 2002

Index S&P 500 E-mini CME Sep 1997

Index S&P MidCap 400 E-mini CME Jan 2002

Index S&P E-mini Health Care Sector CME Mar 2011

Index S&P E-mini Materials Sector CME Mar 2011

Index S&P E-mini Industrial Sector CME Mar 2011

Index S&P E-mini Energy Sector CME Mar 2011

Index S&P E-mini Utilities Sector CME Mar 2011

Index S&P E-mini Technology Sector CME Mar 2011

Index NASDAQ 100 CME Apr 1996

Index Nikkei 225 Yen CME Feb 2004

Index NASDAQ 100 E-mini CME Jun 1999

Index Nikkei 225 CME Dec 1989

Index Russell 1000 Growth ICE May 2010

Index Russell 1000 Mini ICE Sep 2002

Index Russell 2000 Mini ICE Aug 2007

Index Russell 1000 Value ICE May 2010

Index S&P 500 CME Apr 1982

39

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