CDS Momentum: Slow Moving Credit Ratings and Cross-Market Spillovers
59 Pages Posted: 13 Apr 2014 Last revised: 1 Nov 2014
Date Written: September 2, 2014
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: Suggested Citation