Is Momentum a Risk Factor? Evidence from Option-Implied Expected Returns

The risk-based explanation of momentum asserts that the anomaly reflects compensation for exposure to a priced, systematic risk. I test whether momentum exposure indeed generates an expected return premium using forward-looking option-implied expected returns, which sidestep the limitations of ex-post realized return proxies. Contrary to the hypothesis, momentum expected returns range from near-zero during “normal” markets, to negative during and after major downturns. Momentum expected returns move inversely with the market risk premium, as dynamically rebalanced momentum portfolios long low-risk and short high-risk stocks when equity premia increase around downturns. However, somewhat puzzlingly, the estimated momentum premium is negative during downturns even after controlling for other popular premia drivers. This implies the existence of correlated, but omitted, risk factors. Overall, momentum premium estimates are inconsistent with the hypothesis of momentum as an orthogonal risk factor. Findings suggest that momentum expected returns are driven by factor tilts rather than a separate risk premium.