This study introduces a coherent framework that links together various momentum measures, market beta, and idiosyncratic risk (IRISK).... Show moreThis study introduces a coherent framework that links together various momentum measures, market beta, and idiosyncratic risk (IRISK). Momentum is measured as lagged 12-month price momentum (MOM) and volatility adjusted momentum (MOMV). The interaction effect of the three factors is tested. It is found that for 70.64% of the time, a high beta high IRISK stock is more likely to be a top 30% MOM stock than a mid 40% MOM stock. Top MOM exhibits significant bias, 30.81% on average, on high beta high IRISK stocks. Such bias tends to be weaker late in an economy recession. In contrast, top MOMV is less sensitive to high beta and high IRISK. Further, for both MOM and MOMV, it is shown that equally weighted momentum portfolios are driven by high beta high IRISK stocks, especially during a momentum crash. To enhance momentum strategies, risk-based weighting schemes, minimum variance (minVar) and risk parity (ERC), are implemented. In the long run, ERC shows a slight improvement compared to equally weighting, while minVar is able to significantly reduce total risk and tail loss at a cost of sacrifice in performance. A dynamic risk weighting scheme based on changes in market dispersion is proposed to balance the benefit and cost of miVar. Such approach is shown to significantly reduce tail loss and improve Sharpe ratio. Show less
