Market downturns, zero investment strategies and systematic liquidity risk

Abstract

We analyse the behaviour of returns of various zero-investment (ZI) strategies motivated by the well-reported return crashes witnessed for momentum anomaly in down market states (DMS). We find that momentum crashes during market downturns are not unique. Instead, our results show that an alternating return generating process is at work across ZI strategies: almost half of ZI strategies exhibit momentum-like tendencies while the remainder displays an opposite pattern. In sum, this design is linked to the sign of systematic liquidity beta and the strength of falls/rises depend on the illiquidity gaps between the long and short portfolios of studied ZIS.