Risk-managed industry momentum and momentum crashes

Klaus Grobys Joni Ruotsalainen Janne ij

This draft: September 28, 2016

Abstract
This is the first paper that investigates Barosso and Santa-Claras (2015) risk-managed
momentum strategy in an industry momentum setting. We investigate traditional momentum
strategies and Novy-Marx (2012) strategy. We also explore the impact of different variance
forecast horizons on the average payoffs. We find that risk-managed industry momentum payoffs
generate considerably higher returns than plain momentum strategies. Notably, risk-managed
payoffs increase linearly as the time window for variance forecasts are contracted which is
consistent for all different strategies.

Keywords: asset pricing, momentum crash, industry momentum, optionality effect

JEL classification: G12, G14

K. Grobys
Department of Accounting and Finance, University of Vaasa, Wolffintie 34, 65200 Vaasa, Finland
e-mail: klaus.grobys@uwasa.fi; grobys.finance@gmail.com

J. Ruotsalainen (corresponding author)

Inderes Oy, Itmerenkatu 5, 00180, Helsinki, Finland,
e-mail: joni.ruotsalainen@inderes.fi

J. ij
Department of Accounting and Finance, University of Vaasa, Wolffintie 34, 65200 Vaasa, Finland
e-mail: jja@uwasa.fi.

Electronic copy available at: http://ssrn.com/abstract=2844140

1. Introduction
The momentum anomaly as documented first by Jegadeesh and Titman (1993) is one of the most
debated in the literature. Barroso and Santa-Clara (2015) highlight that Momentum returns are in
particular puzzling because of their negative correlations with the market and value factor.
Implemented in the US stock market, this trading strategy generated monthly excess returns of
1.75% after risk-adjustment in the 1927 to 2011 period. While most papers focus on equity
momentum, Asness, Moskowitz, and Pedersen (2013) document the ubiquity of momentum
payoffs across eight different asset classes. Even though Grinblatt and Titman (1989, 1993) find
that momentum strategies are popular among most mutual fund managers, recent research from
Daniel and Moskowitz (2013) shows that momentum returns are subject to remarkable crashes.
The authors find that these so-called momentum crashes occur during strong market reversals.
On the other hand, Moskowitz and Grinblatt (1999) explored the returns from a strategy
of buying firms in industries that were winners over a past ranking period and shorting an equal
dollar amount of firms in the loser industries. They concluded that momentum effects are mainly
driven by industry factors and show that the profitability of individual stock momentum
strategies could be substantially explained by industry momentum. In contrast, Grundy and
Martin (2001) argued that in systems accounting for a one-month interval between the six-month
formation period and the investment month, neither random nor real value-weighted industry
strategies, as documented in Moskowitz and Grinblatt (1999), earn momentum profits. Grundy
and Martin (2001) highlighted that the profitability of an industry momentum strategy comes in
the month immediately after the formation period. Moreover, Pan et al. (2004) adopted
Moskowitz and Grinblatts (1999) view and attempted to link the sources of profits to industry
momentum by decomposing profits to momentum strategies applied onto industry portfolios into
three components, and find that the industry momentum effect is primarily due to return own-
autocorrelations. Hou, Karolyi and Kho (2011) investigated which factors were important in
explaining the cross-sectional variation in global stock returns and find both firm-level and
industry-level momentum forces at work in global stock returns supporting Moskowitz and
Grinblatt (1999). Although there is research investigating industry momentum effects, it has not
provided decisive evidence on whether momentum arises principally from industry factors.
The purpose of this paper is to investigate the profitability of different risk-managed
industry momentum strategies and to explore their behaviors in the presence of strong market

Electronic copy available at: http://ssrn.com/abstract=2844140

reversals. We use 49 Fama and French value-weighted industry portfolios and implement three
popular momentum trading strategies. For all strategies we sort those industry portfolios in six
groups where group one is the loser portfolio group (PG 1) and group six is the winner portfolio
group (PG 6). Every zero-cost momentum strategy is long on PG 6 and short on PG1. We follow
the main stream of academic literature and focus exclusively on the one-month holding period
payoffs. The weights for the risk-managed momentum portfolios are compounded in the same
way as detailed in Barroso and Santa-Clara (2015). All strategies were risk-adjusted using the
Fama and French (1993) three-factor model. To investigate optionality effects during market
reversals, we run for all strategies optionality regressions as in Daniel and Moskowitz (2013).
Our paper contributes to the literature in many important ways. While Barroso and Santa-
Clara (2015) provide evidence for risk-managed momentum strategies for the US, France,
Germany, Japan and the UK, there is no paper investigating the profitability of risk-managed
momentum in an industry momentum setting. We close this gap in the literature and extend
Barosso and Santa-Claras (2015) risk-managing strategy to an industry momentum setting, as in
Moskowitz and Grinblatt (1999) and Grundy and Martin (2001). If industry momentum
subsumes individual stock momentum, as argued for by Moskowitz and Grinblatt (1999) and Pan
et al. (2004), then we would expect that risk-managed industry momentum produced similar
results as individual stock momentum. Conversely, if the opposite was true, one might conjecture
that individual stock momentum and industry momentum stem from different origins. We also
contribute to the literature by not only focusing on the traditional 12-2 strategy as most papers
do, but we also explore the profitability of risk-managing moreover the 6-2 strategy and Novy-
Marxs (2012) 12-7 strategy, referred to as intermediate momentum. In doing so, we also explore
the impact of estimating the realized volatility employing different time windows on the
profitability of risk-managed industry momentum. Finally, there is no paper available that would
explore Daniel and Moskowitzs (2013) optionality effects in the context of industry momentum
payoffs or risk-managed industry momentum payoffs. This paper remedies those gaps in the
literature.
Our results provide strong evidence for the profitability of risk-managed industry
momentum across strategies. Risk-managed industry momentum payoffs generate strictly higher
Sharpe ratios than the traditional counterparts, supporting Barosso and Santa-Claras (2015)
findings in different stock universes. Surprisingly, Novy-Marxs (2012) 12-7 strategy and the

3
risk-managed strategy in the spirit of Barosso and Santa-Clara (2015) do not outperform the
corresponding 6-2 strategies in our industry setting. Interestingly, neither the 12-2 nor the 6-2
strategies implemented in our industry universe are subject to Daniel and Moskowitzs (2013)
optionality effects, whereas Novy-Marx (2012) 12-7 strategy exhibits optionality effects. The
effects are, however, the opposite of what is reported in Daniel and Moskowitz (2013). While
Daniel and Moskowitz (2013) find that stock momentum in the US market is effectively a short
call option on the market, the 12-7 strategy implemented in an industry setting appears to be a
long call option on the market like the inverted credit risk, as documented in Grobys (2016). On
the other hand, implementing Barosso and Santa-Claras (2015) risk-managing strategy, this
optionality effect becomes statistically insignificant and increases the Sharpe ratio by 25%.
The paper is organized as follows. The next section provides the empirical framework.
The last section concludes.

2. Empirical Framework
2.1 Data
We employ daily and monthly data for 49 value-weighted industry portfolios downloaded from
Kenneth Frenchs website. We employ daily data from July 1, 1926 to September 30, 2014 and
monthly data from July 1926 to September 2014. For each month, starting in April 1927, we
construct three different momentum strategies.

2.2 Momentum portfolio sorts

All industry portfolios were sorted by their cumulative past returns in an increasing order into six
groups. The first group (loser) contains the 1/6 of equal-weighted industry portfolios
exhibiting the lowest cumulative returns for the period t-6t-2, whereas the sixth group
(winner) contains the 1/6 of equal-weighted industry portfolios exhibiting the highest
cumulative returns for the same period. This approach is in line with Moskowitz and Grinblatt
(1999) who also make use of an equal weighting scheme across winner/loser industries. Each
portfolio group forms a well-diversified equity basket. This strategy was updated and rebalanced
at the beginning of each month and dubbed the 6-2 strategy as in Novy-Marx (2012). The
traditional 12-2 strategy examined in Grundy and Martin (2001) and Novy-Marxs (2012) 12-7
strategy which was shown to perform remarkably well when implemented among US stocks

4
were also modeled. The zero-cost portfolios were compounded by selling the loser and buying
the winner portfolio. In Table 1 we report the summary statistics of these three popular
momentum strategies implemented in the industry universe. From Table 1 it becomes evident
that all strategies generate returns statistically significant on a 1% level. The 12-2 strategy
generates the highest payoff of 1.06% per month with a Newey-West (1978) t-statistic of 5.06.
Interestingly, the past returns and holding period returns exhibit very similar patterns for the 6-2
and 12-7 strategies. Contrary to Novy-Marx (2012), the results from Table 1 do not provide
evidence that the 12-7 strategy based on intermediate past returns would outperform the 12-2 or
6-2 strategies.

2.3 Realized volatility

Following Barroso and Santa-Clara (2015), we use the realized volatility approach to estimate
the realized volatilities of our zero-cost momentum strategies as

,, = ,, , (1)

where ,, is the realized variance of strategy z in month t, and ,, are the squared daily

return over the trading days in the current month, and are the exact number of trading days in
that respective month. Unlike Barroso and Santa-Clara (2015), we employ the exact number of
trading days for each month varying from 15 to 27. In Figure A.1 in the appendix the trading
days are plotted over the sample period. In Figure 1 we plot the realized volatility for the 12-2
momentum strategy. Comparing Figure 1 with Figure 2 in Barroso and Santa-Clara (2015), we
see that the realized volatility for the zero-cost momentum portfolio employing industry
portfolios is strictly lower than realized volatility for the 12-2 zero-cost momentum portfolio that
is the matter of investigation in Barroso and Santa-Claras (2015) research. The highest level of
realized volatility is 69.77% in November 1929 and the lowest level is 1.74% in April 1951.1

2.4 Risk-managed momentum

As proposed in Barroso and Santa-Clara (2015), we use used an estimate of momentum risk to
scale the exposure to the strategy to have constant risk over time. For each month t and strategy z
we compute three different variance forecasts , , from daily returns in the previous period j,

1
The realized volatilities for the 6-2 and 12-7 strategies are very similar and available from the authors upon
request.

5
where j can either be six months, three months or one month. Let , , be the monthly

returns of momentum strategy z and , , ,{ } be the daily returns and the time
series of the dates of the last trading sessions of each month. Then the variance forecasts are

, , = 21 , , /126 for j=1 (2.1)

, , = 21 , , /63 for j=2 (2.2)

, , = 21 , , /21 for j=3 (2.3)

In our notation, WML is the zero-cost momentum portfolio of strategy z and z can either be the
12-2, 6-2, or 12-7 strategy. We then use the forecasted variances to scale the returns as
, , = , , , (3)
, ,

where , , is the unscaled momentum payoff of strategy z at time t, , , is the scaled

or risk-managed momentum, and is a constant corresponding to the target level of
volatility. As documented in Barroso and Santa-Clara (2015), scaling corresponds to having a
weight in the long and short legs that is different from one and varies over time and we choose
= 12% as in Barroso and Santa-Clara (2015).
In Figure 2 we report the distribution of the weights over time. Unlike Barroso and Santa-
Clara (2015), who report weights varying between 0.13 and 2.00 for the scaling factor, the
weights for the scaled industry momentum range between 0.34 and 4.55. A possible explanation
for that is that the level of realized volatility for the industry momentum is strictly lower than the
realized volatility for stock momentum. 2
Next, we investigate the profitability of risk-managed momentum. In Table 2 we report
the average payoffs of our three different momentum strategies. All strategies are risk-adjusted
by regressing the spreads on the Fama and French (1993) three factor model. Considering the
plain momentum strategies, from Table 2 we observe that the 12-2 strategy performed the best
and generated raw and risk adjusted returns of 1.06% and 1.09% per month. The payoffs are
statistically significant on any level. Contrary to Novy-Marx (2012), in our industry momentum
setting the 6-2 and 12-7 strategies generate very similar returns that are strictly lower the payoffs
of the 12-2 strategy. From Table 2 it also becomes evident that the risk-managed payoffs are

2
Using a three months and one month period to estimate the variance forecasts leads to very similar results. The
results are available from the authors upon request.

6
significantly higher than the plain momentum payoffs, which strongly supports Barroso and
Santa-Clara (2015). Notably, the average payoffs increase linearly as we move from variance
forecast j=1 (e.g., 6 months volatility) to variance forecast j=3 (e.g., 1 month volatility). This
result implies that using variance forecasts in the most recent past (e.g., in the previous month) is
actually more accurate than using data over the past six months. In Table 3 we report the
descriptive statistics for all different momentum strategies. From Table 3 we observe that the
kurtosis for all risk-managed strategies is considerably lower than for the plain strategy,
irrespective of which strategy or variance forecast we consider. We also observe that the
skewness often interpreted as crash-risk in the literature is either substantially lower or even
becomes positive after risk-managing. For instance, when we employ the variance forecast based
on a three month period, the skewness is positive, irrespective of which strategy we consider. In
Figure 3 and 4 we plot the 12-2 plain industry momentum strategy and the risk-managed strategy
over the January 1930 to December 1939, and January 2000 to December 2009 period,
respectively. Visual inspection of Figures 3 and 4 shows, that both strategies behave very similar
during those periods of economic stress. The effects of risk-managed momentum appear to be
much stronger for stock momentum, as shown in Figure 6 Panel A and B in Barroso and Santa-
Clara (2015). The reason is perhaps that industry portfolios respond differently from stocks. The
portfolio risk is ex-ante lower when employing well-diversified industry portfolio compared to
individual stocks as in Barroso and Santa-Clara (2015).

2.5 Optionality effects

In a recent paper, Daniel and Moskowitz (2013p. 42) find that in extreme market environments
following a long market downturn, the market prices of past losers embody a very high premium.
When poor market conditions ameliorate and the market starts to rebound, the losers experience
strong gains, resulting in a momentum crash as momentum strategies short these assets.
Their findings indicate that in bear market states, when market volatility is high, the down-
market betas of the past-losers are low, but the up-market betas are very large which results in
these so-called momentum crashes. However, Barroso and Santa-Clara (2015) show that scaling
with forecasted variances is different from hedging with market betas because the most
predictable component of momentum variance is the momentum-specific risk. To investigate
whether the risk-managed industry momentum strategies are subject to Daniel and Moskowitzs

7
(2013) optionality effect, we employ Daniel and Moskowitzs (2013) optionality regression, that
is, we use the following regression equation:

, , = + + , + , , + , , , , + , , (4)
where , , denotes the zero-cost industry momentum strategy z at time t, and j indicates the
time window used to estimate the variance forecast (see equations 2.1-2.3). Furthermore,
denotes the risk-adjusted return of the unconditional model and denotes the unconditional
market sensitivity (e.g., beta). , denotes the value-weighted market factor in excess returns
(e.g., excess CRSP returns), , is an ex-ante bear market indicator that has a value of 1 if the
cumulative market return in the 24 months leading up to the start of month t is negative, and a
value of zero otherwise. The binary variable , is a contemporaneous up-market indicator that
has a value of 1 if the excess market return is greater than zero, and a value of zero otherwise.
The results are reported in Tables 4 6. Contrary to Daniel and Moskowitz (2013), the 12-2
industry momentum strategy does not exhibit any option-like behavior. Table 4 shows that the
estimated parameter for , are statistically not different from zero, irrespective of whether the
strategy is risk-managed or not and irrespective of which variance forecasts are taken into account.
Interestingly, we find that the parameter is statistically significant for the plain 12-2 industry
momentum strategy but insignificant for all risk-managed strategies. This implies that in bear markets, the
payoffs of risk-managed industry momentum strategies do not co-move with market movement which
makes these strategies preferable for investors who do not want to be exposed to market risk in any
economic state.
From Table 5 it becomes evident that neither the plain 6-2 industry momentum strategies nor the
risk-managed counterparts are significantly exposed to any kind of market risks. However, the parameter
estimates for show that all risk-managed industry momentum strategies generate higher payoffs than
the plain industry momentum strategy. This result provides strong support for Barroso and Santa-Clara
(2015). We also observe that the estimated average payoffs linearly increase as we move from a
variance forecast using a six month time window (e.g., 6M volatility) to a variance forecast using
a one month time window (e.g., 1M volatility). This result implies that recent volatility might
cache more accurate information than intermediate volatility.
Surprisingly, we observe from Table 6 that Novy-Marx (2012) 12-7 strategy that worked
out very well when implemented among US stocks, is significantly exposed to plain market risk,
which is shown by the significance of the estimated parameters . Risk-managing does not

8
reduce the exposure. Notably, the estimated parameter , that indicates Daniel and
Moskowitzs (2013) optionality effect is statistically significant different from zero on a 1%
level. This result is very surprising because the 12-2 strategy implemented among US stocks
exhibits according to Daniel and Moskowitzs (2013) research a significantly negative parameter
estimate. This means while stock momentum in the US market is effectively a short call option
on the market, the 12-7 plain momentum strategy implemented in an industry setting appears to
be a long call option on the market. A similar effect has been documented in Grobys (2016) for
the inverted credit risk spread. Employing variance forecasts based on time windows of six or
three months diminishes this effect considerably while employing a variance forecast of one
month has virtually no impact. Again, and consistent with our previous findings, we observe that
the average payoffs are linearly increasing as we move from a variance forecast using a six
month time window (e.g., 6M volatility) to a variance forecast using a one month time window
(e.g., 1M volatility). Also we find that the average payoffs of any risk-managed strategy is at
least twice as much as the average payoff of the plain strategy which is 0.53% per month.

2.5 Robustness
First, we followed Barroso and Santa-Clara (2015) and performed a sample split analysis where
we split the sample in two halves. The first subsample is from June 1927 to July 1971 and the
second is from August 1971 to September 2014. We then repeat the regression analysis for risk-
adjustments employing the Fama and French (1993) three-factor model. The results are reported in Tables
A.2 and A.3 in the appendix. Interestingly, the payoffs of the 12-2 and 6-2 strategies are higher for the
first subsample. However, we observe that the risk-managed payoffs are clearly higher than the plain
momentum strategies, irrespective of which strategy we consider. Notably, the sample average payoff of
Novy-Marxs (2012) 12-7 plain momentum strategy does not generate any significant payoffs in the first
sample. In contrast to the first sample, Table A.3 shows that in the second sample this strategy clearly
dominates all other strategies for both, the plain strategy and risk-managed strategies. This result is
strongly supporting Novy-Marxs (2012) finding that, in the 1990-2010 period, the 12-7 strategy is the
most profitable momentum strategy.
Another concern could be that the increased payoffs of the risk-managed industry
momentum strategies could perhaps be driven to an increased exposure to some risk-factors. In
order to investigate this issue, we used the Fama and French (2015) five-factor model and
regressed the payoffs of all different industry momentum strategies on the excess market factor,

9
the size, value, profitability, and investment factors. The results are reported in Table A.4 in the
appendix. Surprisingly, we observe that none of the strategies exhibits a significant exposure to
any of the zero-cost risk factors. All parameter estimates are statistically not different from zero.
Notably, the plain and risk-adjusted 12-7 industry momentum strategies exhibit a significant
exposure to the excess market factor. However, the R-square varying between 0-2% shows that
the payoffs are virtually unexplained by the Fama and French (2015) five-factor model.

3. Conclusion
In this paper, we investigate the profitability of popular momentum trading strategies
implemented in an industry universe. We consider the traditional 6-2 and 12-2 strategies as well
as Novy-Marx (2012) strategy based on intermediate past performance. We extend previous
research and also explore the impact of different time windows for estimating the variance
forecasts on the average risk-managed industry momentum payoffs. We also investigate whether
or not the plain industry momentum and the risk-managed counterparts are subject to optionality
effects in the presence of bear market regimes. We find that risk-managed industry momentum
payoffs are considerably larger than the plain payoffs. Our findings also consistently indicate that
the average payoffs of risk-managed industry momentum increase as the time windows for
estimating the variance is contracted, that is, for all strategies we find consistently that using a
one-month time window to estimate the variance forecast, based on realized volatility, produces
higher average payoffs than six- or three-month time windows. We also find that the 12-2 and
the 6-2 industry momentum strategies are not subject to any optionality effect, irrespective of
whether we consider the plain momentum strategies or any of the risk-adjusted counterparts. The
results for the 12-7 strategy implemented in an industry setting are ambiguous and left for future
research. Since risk-managed industry momentum produced similar results as individual stock
momentum, we provide further evidence for that industry momentum might subsume individual
stock momentum, as argued for by Moskowitz and Grinblatt (1999) and Pan et al. (2004). Future
research could investigate the profitability of risk-managed momentum in other asset classes.

10
References
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Everywhere. The Journal of Finance 68, 929-985.

Barroso, Pedro & Santa-Clara, Pedro, 2015. Momentum Has Its Moments. Journal of Financial
Economics 116, 111-120.

Daniel, K., Moskowitz, T., 2013. Momentum Crashes, Columbia Business School Working
Paper, New York.

Fama, E. and French, K., 1993. Common Risk Factors in the Returns on Stocks and Bonds.
Journal of Financial Economics 33, 3-56.

Fama, E. and French, K., 2015. A Five-Factor Asset Pricing Model. Journal of Financial
Economics 116, 1-22.

Grinblatt, M., and Titman, S.,1989. Mutual fund performance: an analysis of quarterly portfolio
holdings. Journal of Business 62,394415.

Grinblatt, M.,and Titman, S.,1993.Performance measurement without benchmarks: an

examination of mutual fund returns. Journal of Business 66,4768.

Grobys, K., 2016. Momentum crash, credit risk and optionality effects in bear markets and crisis
periods: evidence from the US stock market, Applied Economics Letters, forthcoming.

Grundy, B. and M. Spencer, 2001. Understanding the Nature of the Risks and the Source of the
Rewards to Momentum Investing. The Review of Financial Studies 14, 29-78.

Hou, K., Karolyi, G.A., and Kho, B.C., 2011. What Factors Drive Global Stock Returns? Review
of Financial Studies 24, 2527-2574.

11
Jegadeesh, N., Titman, S., 1993, Returns to buying winners and selling losers: Implications for
stock market efficiency, Journal of Finance 48, 3591.

Moskowitz, T. J. and M. Grinblatt, 1999. Do Industries Explain Momentum? The Journal of

Finance 54, 1249-1290.

Newey, W. K. and K.D. West, 1987. A Simple, Positive Semi-definite, Heteroskedsticity and
Autocorrelation Consistent Covariance Matrix. Econometrica 55, 703-708.

Novy-Marx, R., 2012. Is momentum really momentum? Journal of Financial Economics 103,

Pan, M.-S., Liano, K. and Huang, G.-C., 2004. Industry Momentum Strategies and
Autocorrelations in Stock Returns. Journal of Empirical Finance 11, 185-202

12
Table 1. Summary statistics

This Table reports the summary statistics of three different industry momentum strategies. All industry
portfolios were sorted by their cumulative past returns in an increasing order into six groups. The first
group (loser) contains the 1/6 of equal-weighted industry portfolios exhibiting the lowest cumulative
returns for the period t-6t-2, whereas the sixth group (winner) contains the 1/6 of equal-weighted
industry portfolios exhibiting the highest cumulative returns for the same period. This strategy was
updated and rebalanced at the beginning of each month and dubbed the 6-2 strategy as in Novy-Marx
(2012). Analogously, the traditional 12-2 strategy examined in Grundy and Martin (2001) and Novy-
Marxs (2012) 12-7 strategy were modeled. We report the average returns (e.g., returns) and the
cumulative past returns (e.g., past returns) of the six portfolio groups. The data were downloaded from
Kenneth Frenchs website. The sample period is from June 1927 to September 2014. Newey-West (1978)
t-statistics are given in parentheses.

13
 Loser (L) PG2 PG3 PG4 PG5 Winner (W) W-L

Panel A. 12-2 strategy

Return 0.40 0.78 1.00 1.18 1.16 1.46 1.06***

(5.06)
Past -14.11 1.77 8.79 15.10 23.04 40.36
Return

Panel B. 6-2 strategy

Return 0.54 0.94 1.03 1.03 1.12 1.30 0.76***

(3.71)
Past -11.55 -0.66 4.27 8.75 14.46 26.58
Return

Panel C. 12-7 strategy

Return 0.56 0.83 1.00 1.07 1.12 1.33 0.77***

(2.72)
Past -11.48 -0.60 4.35 8.85 14.60 26.93
Return

***Statistically significant on a 1% level.

14
Table 2. Risk-managed industry momentum strategies

This Table reports the traditional and risk-managed industry momentum strategies. The returns are risk-
adjusted by regressing the zero-cost strategies on the Fama and French (1993) three-factor model. The
sample period is from June 1927 to September 2014. Newey-West (1978) t-statistics are given in
parentheses.

Risk-managed payoffs

Strategy Type Traditional 6 Months 3 Months 1 Month

volatility volatility volatility

12-2 Raw return 1.06*** 1.65*** 1.78*** 1.92***

(5.06) (5.49) (5.76) (5.73)

Risk-adjusted 1.09*** 1.64*** 1.78*** 1.91***

return (5.10) (5.60) (5.86) (5.81)

6-2 Raw return 0.76*** 1.30*** 1.39*** 1.43***

(3.71) (4.97) (5.23) (4.84)

Risk-adjusted 0.75*** 1.26*** 1.37*** 1.41***

return (3.64) (5.04) (5.28) (4.90)

12-7 Raw return 0.77*** 1.14*** 1.22*** 1.33***

(2.72) (3.97) (4.05) (4.16)

Risk-adjusted 0.79** 1.11*** 1.19*** 1.31***

return (2.51) (3.75) (3.83) (3.93)
***Statistically significant on a 1% level.

**Statistically significant on a 5% level.

15
Table 3. Descriptive statistics

This Table reports the descriptive statistics of traditional and risk-managed industry momentum
strategies. The sample period is from June 1927 to September 2014.

Panel A: 12-2 strategy

Risk-managed
Traditional
Strategy 6 Months 3 Months 1 Month
volatility volatility volatility

Mean 1.06 1.65 1.78 1.92

Median 1.01 1.34 1.45 1.46
Maximum 51.34 42.89 55.27 67.32
Minimum -56.60 -38.50 -36.38 -37.13
Std.Dev. 6.51 8.31 8.61 9.28
Skewness -0.20 0.12 0.41 0.65
Kurtosis 19.80 6.05 6.88 8.31
JB 12330.53 405.53 685.35 1304.52
Probability 0.00 0.00 0.00 0.00
Sharpe ratio 0.56 0.69 0.72 0.72

Panel B: 6-2 strategy

Risk-managed
Traditional
Strategy 6 Months 3 Months 1 Month
volatility volatility volatility

Mean 0.76 1.30 1.39 1.43

Median 0.79 1.05 1.06 0.96
Maximum 37.67 38.84 55.47 54.21
Minimum -62.75 -41.11 -34.83 -63.90
Std.Dev. 5.98 7.18 7.56 8.44
Skewness -1.50 -0.16 0.26 -0.24
Kurtosis 22.91 6.47 7.82 9.80
JB 17703.02 528.39 1023.99 2025.00
Probability 0.00 0.00 0.00 0.00
Sharpe ratio 0.44 0.63 0.64 0.59

16
Panel B: 12-7 strategy

Risk-managed
Traditional
Strategy 6 Months 3 Months 1 Month
volatility volatility volatility

Mean 0.77 1.14 1.22 1.33

Median 0.77 1.07 1.11 1.21
Maximum 46.78 41.61 46.44 49.72
Minimum -52.21 -33.49 -36.52 -43.43
Std.Dev. 6.40 7.52 7.87 8.50
Skewness -1.12 -0.17 0.02 -0.05
Kurtosis 21.39 6.75 7.67 8.82
JB 14981.87 615.00 951.76 1478.08
Probability 0.00 0.00 0.00 0.00
Sharpe ratio 0.42 0.53 0.54 0.52

17
Table 4. Optionality regressions for the 12-2 industry momentum strategies

Coeff. Variable zero-cost Risk-adjusted Risk-adjusted Risk-adjusted

6M volatility 3M volatility 1M volatility

1 1.08*** 1.78*** 1.85*** 1.95***

(4.94) (6.25) (6.38) (6.27)

-1.34* -1.06 -1.29 -1.39

(-1.77) (-1.08) (-1.29) (-1.30)

, 0.04 0.03 0.05 0.05

(0.84) (0.51) (0.77) (0.68)

, , -0.33*** -0.12 -0.21 -0.22

(-2.74) (-0.75) (-1.29) (-1.30)

, , , , 0.25 0.03 0.11 0.14

(1.53) (0.14) (0.51) (0.62)

0.01 0.00 0.00 0.00

Log likelihood -3387.99 -3658.63 -3676.44 -3747.65

***Statistically significant on a 1% level.

*Statistically significant on a 10% level.

18
Table 5. Optionality regressions for the 6-2 industry momentum strategies

Coeff. Variable zero-cost Risk-adjusted Risk-adjusted Risk-adjusted

6M volatility 3M volatility 1M volatility

1 0.81*** 1.36*** 1.40*** 1.55***

(4.03) (5.53) (5.53) (5.47)

I -1.20* -0.67 -0.67 -1.81*

(-1.73) (-0.80) (-0.77) (-1.86)

R , 0.04 0.05 0.07 0.02

(0.87) (0.96) (1.16) (0.26)

I , R , -0.16 -0.07 -0.11 -0.04

(-1.47) (-0.51) (-0.81) (-0.25)

, I , I , R , 0.09 -0.05 -0.03 0.11

(0.62) (-0.30) (-0.18) (0.53)

R 0.01 0.00 0.00 0.00

Log likelihood -3294.20 -3504.07 -3531.12 -3649.39

***Statistically significant on a 1% level.

*Statistically significant on a 10% level.

19
Table 6. Optionality regressions for the 12-7 industry momentum strategies

Coeff. Variable zero-cost Risk-adjusted Risk-adjusted Risk-adjusted

6M volatility 3M volatility 1M volatility

1 0.53** 1.06*** 1.08*** 1.15***

(2.47) (4.09) (4.06) (4.01)

I -0.65 -0.79 -0.91 -1.22

(-0.89) (-0.88) (-0.99) (-1.24)

R , 0.10** 0.14** 0.15** 0.14**

(2.01) (2.48) (2.50) (2.11)

I , R , -0.53*** -0.34** -0.41*** -0.47***

(-4.58) (-2.45) (-2.82) (-3.02)

, I , I , R , 0.47*** 0.21 0.29 0.44**

(3.10) (1.15) (1.50) (2.08)

R 0.02 0.01 0.01 0.01

Log likelihood -3363.02 -3554.04 -3584.51 -3665.06

***Statistically significant on a 1% level.

*Statistically significant on a 10% level.

20
Figure 1. Realized volatility of the zero-cost industry momentum portfolio employing the
12-2 strategy

0,80

0,70

0,60

0,50

0,40

0,30

0,20

0,10

0,00
192705 193911 195205 196411 197705 198911 200205

21
Figure 2. Scaling of the risk-managed 12-2 zero-cost portfolio

This Figure plots the investment weights for the 12-2 momentum portfolio over time. To scale
the payoffs, we use a time window of six months to estimate the variance forest. The sample
period is from October 1927 to September 2014.

5,00

4,50

4,00

3,50

3,00

2,50

2,00

1,50

1,00

0,50

0,00
192710 193602 194406 195210 196102 196906 197710 198602 199406 200210 201102

22
Figure 3. Cumulative momentum and risk-managed momentum returns for the January
1930 to December 1939 period

This Figure shows the cumulative payoffs of the plain 12-2 strategy and the risk-managed
strategy using a variance forecast over the past six month period. The sample period is from
January 1930 to December 1939.

150

100

50
Cumulative Market excess
returns
Cumulative momentum
0
returns
193001 193202 193403 193604 193805
Cumulative risk-managed
momentum returns
-50

-100

-150

23
Figure 4. Cumulative momentum and risk-managed momentum returns for the January
2000 to December 2009 period

This Figure shows the cumulative payoffs of the plain 12-2 strategy and the risk-managed
strategy using a variance forecast over the past six month period. The sample period is from
January 2000 to December 2009.

150

100

Cumulative market excess

50 returns
Cumulative momentum
returns

0 Cumulative risk-adjusted
200001 200202 200403 200604 200805 momenutm return

-50

-100

24
Appendix

Figure A.1. Trading days for the period July 1926 to September 2014

30

25

20

15

10

0
1 151 301 451 601 751 901 1051

25
Table A.2. Risk-managed industry momentum strategies for the first subsample

This Table reports the traditional and risk-managed industry momentum strategies. The returns are risk-
adjusted by regressing the zero-cost strategies on the Fama and French (1993) three-factor model. The
sample period is from June 1927 to July 1971. Newey-West (1978) t-statistics are given in parentheses.

Risk-managed payoffs

Strategy Type Traditional 6 Months 3 Months 1 Month

volatility volatility volatility

12-2 Raw return 1.28*** 1.99*** 2.19*** 2.43***

(3.61) (3.90) (4.19) (4.28)

Risk-adjusted 1.33*** 2.00*** 2.20*** 2.46***

return (3.69) (4.00) (4.29) (4.37)

6-2 Raw return 0.98*** 1.86*** 2.04*** 1.96***

(2.65) (4.14) (4.48) (3.81)

Risk-adjusted 0.95*** 1.82*** 2.02*** 1.90***

return (2.59) (4.18) (4.52) (3.81)

12-7 Raw return 0.64 0.91* 1.00** 1.11**

(1.27) (1.90) (1.98) (2.06)

Risk-adjusted 0.68 0.89* 0.99* 1.11**

return (1.26) (1.82) (1.91) (2.00)
***Statistically significant on a 1% level.

**Statistically significant on a 5% level.

*Statistically significant on a10% level.

26
Table A.3. Risk-managed industry momentum strategies for the second subsample

This Table reports the traditional and risk-managed industry momentum strategies. The returns are risk-
adjusted by regressing the zero-cost strategies on the Fama and French (1993) three-factor model. The
sample period is from August 1971 to September 2014. Newey-West (1978) t-statistics are given in
parentheses.

Risk-managed payoffs

Strategy Type Traditional 6 Months 3 Months 1 Month

volatility volatility volatility

12-2 Raw return 0.85*** 1.32*** 1.37*** 1.41***

(3.85) (4.36) (4.48) (4.33)

Risk-adjusted 0.80*** 1.26*** 1.30*** 1.32***

return (3.42) (4.07) (4.15) (4.00)

6-2 Raw return 0.56*** 0.75*** 0.76*** 0.92***

(3.07) (3.11) (3.08) (3.40)

Risk-adjusted 0.54*** 0.72*** 0.72*** 1.00***

return (2.76) (2.89) (2.82) (3.54)

12-7 Raw return 0.90*** 1.37*** 1.44*** 1.55**

(3.97) (4.45) (4.58) (4.64)

Risk-adjusted 0.82*** 1.28*** 1.34*** 1.43**

return (3.49) (4.04) (4.17) (4.26)
***Statistically significant on a 1% level.

**Statistically significant on a 5% level.

*Statistically significant on a10% level.

27
Table A.4. Risk adjustment using the Fama and French five-factor model

This Table shows the plain and risk-managed (e.g., RM) industry momentum strategies. The
variance forecast are based on a one (e.g., 1 M), three (e.g., 3 M), ore six months (e.g., 6 M)
period. The data were downloaded from Kenneth Frenchs website. The sample period is from
July 1963 until September 2014. Newey-West (1987) t-statistics are given in parenthesis.

Intercept MKT SMB HML RMW CMA

0.82*** 0.07 -0.04 -0.01 -0.10 0.10 0.00
Plain 12-2
(3.52) (1.28) (-0.47) (-0.05) (-0.88) (0.48)

1.30*** 0.12* -0.11 0.02 -0.02 0.08 0.00

12-2 RM
(3.85) (1.84) (-1.02) (0.18) (-0.20) (0.38)
6M
1.35*** 0.12* -0.09 0.06 -0.04 0.03 0.00
12-2 RM
(3.97) (1.93) (-0.93) (0.44) (-0.34) (0.16)
3M
1.35*** 0.13** -0.09 0.09 -0.05 0.06 0.01
12-2 RM
(3.74) (1.99) (-0.92) (0.66) (-0.37) (0.27)
1M
0.61*** 0.02 -0.03 -0.05 -0.03 0.16 0.00
Plain 6-2
(3.29) (0.45) (-0.38) (-0.41) (-0.33) (0.86)

0.88*** 0.06 -0.08 -0.03 0.01 0.15 0.00

6-2 RM
(3.43) (0.92) (-1.02) (-0.22) (0.09) (0.72)
6M
0.92*** 0.06 -0.09 0.00 -0.03 0.10 0.00
6-2 RM
(3.50) (1.00) (-1.18) (0.02) (-0.22) (0.49)
3M
1.18*** 0.00 -0.13 -0.12 -0.03 0.06 0.00
6-2 RM
(4.15) (0.07) (-1.30) (-0.88) (-0.29) (0.26)
1M
0.84*** 0.11*** -0.12 0.12 -0.08 -0.09 0.02
Plain 12-7
(3.75) (2.61) (-1.55) (1.30) (-0.88) (-0.71)

1.31*** 0.16*** -0.15 0.16 -0.07 -0.11 0.01

12-7 RM
(4.17) (2.63) (-1.58) (1.27) (-0.72) (-0.59)
6M
1.35*** 0.17*** -0.14 0.17 -0.07 -0.09 0.01
12-7 RM
(4.24) (2.72) (-1.46) (1.30) (-0.66) (-0.51)
3M
12-7 RM 1.41*** 0.18*** -0.15 0.19 -0.07 -0.07 0.01
1M (4.20) (2.74) (-1.39) (1.28) (-0.59) (-0.34)
***Statistically significant on a 1% level.

** Statistically significant on a 5% level.

*Statistically significant on a 10% level.

28
29