What Drives the Enhanced Momentum Profits of Growth Firms? Mispricing or Risk

Abstract

We examine rational and behavioral explanations for the relatively larger momentum profits of growth firms. Our results provide support for the rational explanation for firms with low idiosyncratic volatility, and are consistent with the notion that growth options cause a wider spread in the risk and returns between winners and losers. However, the evidence is more aligned with the behavioral explanation for firms with high idiosyncratic volatility, which is consistent with the notion that investors are more prone to behavioral biases in the presence of idiosyncratic volatility, and the resulting mispricings are less likely to be immediately arbitraged away.

Keywords: Momentum, Growth options, Idiosyncratic volatility, Market-to-book ratio, Systematic risk

JEL Classification: G12, G14