Momentum, Information Uncertainty, and Leverage - An Explanation Based on Recursive Preferences

45 Pages Posted: 5 Mar 2008 Last revised: 14 Dec 2008

See all articles by Doron Avramov

Doron Avramov

Interdisciplinary Center (IDC) Herzliyah

Satadru Hore

Federal Reserve Bank of Boston

Date Written: December 4, 2008

Abstract

Past work suggests that momentum is among the most robust market anomalies, as well as momentum profitability concentrates in firms with high information uncertainty and high credit risk. This paper shows that such momentum concentrations naturally emerge in an equilibrium setting with mean-reverting dividend growth, persistent expected dividend growth, recursive preferences per Duffie and Epstein (1992), and leverage based on Abel (1999). In particular, when the representative agent is endowed with reasonable riskaversion and time preferences parameters, equilibrium momentum profitability is large in the interaction between high levered and risky cash flow firms. Momentum payoffs rapidly deteriorate and ultimately disappear as either leverage or cash flow risk diminishes.

Keywords: Momentum, Duffie-Epstein Preferences, Information Uncertainty, Early Resolution of Uncertainty

JEL Classification: G12, G14

Suggested Citation

Avramov, Doron and Hore, Satadru, Momentum, Information Uncertainty, and Leverage - An Explanation Based on Recursive Preferences (December 4, 2008). EFA 2008 Athens Meetings Paper; AFA 2009 San Francisco Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1017419 or http://dx.doi.org/10.2139/ssrn.1017419

Doron Avramov

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

Satadru Hore (Contact Author)

Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02116
United States

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