Momentum strategy and credit risk

Su-Lien Lu, Kuo-Jung Lee and Chia-Chang Yu

Applied Financial Economics, 2014, vol. 24, issue 11, 753-762

Abstract: The article first focused on the traditional momentum strategies, and the distance-to-default of the KMV (Kealhofer, McQuown and Vasicek) model was later applied as the proxy of credit risk. Then, based on the credit risk, two factors January effect and business cycle were added to investigate the momentum effect on them and credit risk. Empirical results indicated that investment portfolios had the momentum effects by traditional momentum strategies. After the credit risk was added, when the high-credit-risk group applied the momentum strategies in the mid- and long-term holding periods, significant excess return occurred. For low- and medium-credit-risk groups, the momentum profits only exist in 36-months holding periods. In addition, when credit risk was taken as the basis, and the January effect was included, the study found that positive momentum profits only took place in the low- and medium-credit-risk groups in 36-months holding period. Finally, when credit risk was taken as the basis, and business cycle was included, momentum profits took place during the recession period. Consequently, we found that momentum strategy has different influence on three credit-risk groups. Investors should consider the credit-risk characteristics of their investment portfolio when employing the momentum strategy.

Date: 2014
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DOI: 10.1080/09603107.2014.904487

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