The Crash Risks of Style Investing: Can They Be Internationally Diversified?

Abstract

The crash risks of momentum tend to be higher than those of size and value. International diversification lowers the crash risks of size and value but not momentum. The authors examined the conditional correlations and return co-exceedances of style portfolios across countries and found that this difference in the effect of diversification is due to the left (right) tails of momentum (size and value) portfolios being more correlated than the right (left) tails across countries.S tyle investing has grown in popularity among investors. Even at the retail level, as of 2008, there were more than 2,000 mutual funds and exchange-traded funds in the United States with a market-capitalization or value/growth focus. 1 According to statistics reported by Eun, Lai, de Roon, and Zhang (2010), such products are also becoming widely available in other developed countries. With respect to momentum, Jegadeesh and Titman (1993, p. 66) observed that "a majority of the mutual funds examined by Grinblatt and Titman (1989, 1993) show a tendency to buy stocks that have increased in price over the previous quarter."Many studies that have examined extreme events in the international equity market have focused on developing countries (see, e.g., Forbes and Rigobon 2002;Bae, Karolyi, and Stulz 2003;Bekaert, Harvey, and Ng 2005), but the recent financial crisis reminds us that even developed stock markets are not immune to crashes and tail risks. Taleb (2007) and Reinhart and Rogoff (2009), together with many others in the financial press, have also advised investors to pay more attention to these "rare" events.Motivated by the growth in popularity of style investing and the concerns about extreme events among investors, we examined the tail risks of style investing in the G-7 countries (Canada, France, Germany, Italy, Japan, United Kingdom, and United States) over 1981-2010. We evaluated whether portfolios with different size, value, or momentum tilts-the SMB (small minus big), HML (high minus low), and UMD (up minus down, or past winners minus past losers) portfolios-experience different crash risks and whether these risks can be mitigated through international diversification.■ Discussion of findings. Using both expected shortfall and return skewness as measures, we found that the left-tail risks of UMD are significantly higher than those of SMB and HML. 2 For diversified "world" portfolios (equal-weighted portfolios of the G-7 countries), this difference in left-tail risks across styles is even greater. By calculating conditional correlations (i.e., correlations conditional on returns of different magnitudes) and co-exceedances (i.e., joint occurrences of extreme returns) across countries, we found that the extreme negative returns on UMD in different markets tend to occur together, whereas those on SMB and HML tend to be country specific. In fact, for SMB and HML, the right-tail events tend to be more global in nature. These results suggest that momentum crashes cannot be diversified away internationally and explain why internatio...

Where does the risk lie? Systemic risk and tail risk networks in the Chinese financial market

“…To overcome this drawback, several novel systemic risk measurements have been proposed in the past decade, like marginal expected shortfall (MES) from Acharya et al (2010), realized systemic risk beta from Hautsch et al (2015), co‐exceedances in Chue et al (2015), SRISK from Brownlees and Engle (2015), conditional value‐at‐risk ( CoVaR ) and Δ CoVaR proposed by Adrian and Brunnermeier (2016), and so forth 1 . Among these measures, CoVaR and Δ CoVaR are quite popular and they can capture the tail interconnectedness between financial institutions.…”