Aggregate volatility risk and momentum returns

Abstract

Momentum stocks are exposed to aggregate volatility risk. This paper estimates an exponential generalized autoregressive conditional heteroskedastic model of market volatility to introduce a new volatility risk factor. Winners have negative loadings on this factor, whereas losers have positive loadings. Because volatility risk carries a negative price of risk, the new factor explains 73% of momentum profits. The paper rationalizes the volatility risks of momentum portfolios using growth option arguments and explains why momentum profits are short-lived, depend on market states, and concentrate among firms with high idiosyncratic volatility. Results are robust to controlling for other risk factors and using alternative estimation procedures.