CDS Momentum: Slow Moving Credit Ratings and Cross-Market Spillovers

59 Pages Posted: 13 Apr 2014 Last revised: 1 Nov 2014

Jongsub Lee

University of Florida - Warrington College of Business Administration

Andy Naranjo

University of Florida - Warrington College of Business Administration

Stace Sirmans

University of Arkansas - Department of Finance

Date Written: September 2, 2014

Abstract

Using 5-year credit default swap (CDS) contracts on 1,247 U.S. firms from 2003-2011, we show a 3-month formation and 1-month holding period CDS momentum strategy yields 52 bps per month. By incorporating past CDS return signals, we further show traditional stock momentum strategies avoid abrupt losses during the crisis period and improve their performance by net 104 bps per month. Both within CDS market and across CDS-to-stock market momentum profits exist because CDS returns correctly anticipate future credit rating changes. Our results highlight the adverse effects of sluggish rating updates in creating information efficiency distortions and investment anomalies.

Keywords: Credit default swaps; CDS returns; Credit ratings; Momentum; Spillover; Endogenous liquidity; Credit risk; Information flows

JEL Classification: G12, G14

Suggested Citation

Lee, Jongsub and Naranjo, Andy and Sirmans, Stace, CDS Momentum: Slow Moving Credit Ratings and Cross-Market Spillovers (September 2, 2014). Available at SSRN: https://ssrn.com/abstract=2423371 or http://dx.doi.org/10.2139/ssrn.2423371

Jongsub Lee (Contact Author)

University of Florida - Warrington College of Business Administration ( email )

Department of Finance Insurance & Real Estate
P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-273-4966 (Phone)
352-392-0301 (Fax)

Andy Naranjo

University of Florida - Warrington College of Business Administration ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3781 (Phone)

Stace Sirmans

University of Arkansas - Department of Finance ( email )

WCOB 302
University of Arkansas
Fayetteville, AR 72701
United States

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