Last Updated on 10 February, 2024 by Rejaul Karim
In the financial labyrinth explored by “Momentum and Aggregate Default Risk” from Mays Business School Research Paper No. 2012-39, authored by Arvind Mahajan, Alex Petkevich, and Ralitsa Petkova, a captivating link emerges between momentum returns and shifts in aggregate default risk.
Published on May 15, 2012, by Texas A&M University, University of Denver, and Case Western Reserve University, this study unveils that momentum profits thrive only amidst high default shocks. Winners, intriguingly, carry potentially higher risk than losers during these tumultuous periods, a revelation persisting across international data and traditionally momentum-lacking sub-periods.
The study connects momentum profits to shareholder recovery dynamics during financial distress, portraying winners as more vulnerable in worsening aggregate default conditions due to diminished bargaining power. This research unravels momentum profits as a systematic element intricately woven with aggregate default, offering a rational framework for their comprehension.
Abstract Of Paper
In this paper, we explain momentum profits using innovations in aggregate economy-wide default risk. First, we show that momentum returns are positive only during high default shocks and nonexistent otherwise. Second, we present evidence suggesting that a conditional default shock factor is priced in the cross-section and can explain a large portion of the total momentum returns. According to our results, winners have potentially higher risk than losers during periods of high default shocks. We confirm this finding in alternate sub-periods where momentum is generally not observed and as well as in international data. We also provide an explanation for this finding by linking momentum profits to potential shareholder recovery during financial distress. We find that winners tend to have relatively higher risk in worsening aggregate default conditions due to lower shareholder bargaining power. These results indicate that momentum profits contain a systematic component related to aggregate default and can be explained in a rational framework.
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Texas A&M University – Department of Finance
University of Denver
Case Western Reserve University – Department of Banking & Finance
The findings of this study shed light on the nuanced relationship between momentum profits and aggregate economy-wide default risk. Notably, momentum returns exhibit positivity specifically during periods of heightened default shocks, presenting a dynamic connection between market momentum and systemic risk conditions.
The introduction of a conditional default shock factor proves to be a key determinant in explaining a substantial portion of total momentum returns, uncovering a priced factor in the cross-section. The discerned pattern indicates that, during elevated default shocks, winners in the momentum strategy may carry higher inherent risk than their loser counterparts.
This observation holds true across different sub-periods and international datasets, bolstering the robustness of the findings. The study further delves into the rationale behind this phenomenon, attributing momentum profits to potential shareholder recovery dynamics during financial distress. The systematic component linking momentum profits to aggregate default conditions offers a rational framework for understanding these intricate market dynamics.
Q1: What is the key finding regarding momentum profits in the study, “Momentum and Aggregate Default Risk”?
The study reveals that momentum profits are positive only during periods of high default shocks and are nonexistent otherwise. This dynamic link between momentum returns and elevated default conditions indicates a nuanced relationship between market momentum and systemic risk.
Q2: How does the study explain the relationship between winners and losers in the momentum strategy during periods of high default shocks?
During periods of heightened default shocks, the study suggests that winners in the momentum strategy may carry potentially higher risk than losers. The introduction of a conditional default shock factor is identified as a crucial element in explaining a significant portion of total momentum returns, portraying winners as more vulnerable in worsening aggregate default conditions.
Q3: Is the observed pattern of winners having higher risk during default shocks consistent across different sub-periods and international datasets?
Yes, the study confirms the robustness of its findings by demonstrating that the pattern of winners having potentially higher risk during default shocks holds true not only across different sub-periods but also in international datasets. This consistency reinforces the systematic nature of momentum profits related to aggregate default conditions.