Momentum Crash, Credit Risk and Optionality Effects in Bear Markets and Crisis Periods: Evidence from the US Stock Market

Abstract

This study explores whether the credit risk anomaly exhibits option-like behavior similar to the momentum anomaly. Employing a market-timing regression model as in Daniel and Moskowitz (2013), it finds that the inverted credit risk spread indeed displays option-like behavior in bear market states. Unlike a momentum portfolio, which is effectively a short call option on the market, an inverted credit risk portfolio appears to be a long call option on the market. A strategy that invests 50% in credit risk and 50% in momentum does not exhibit any significant optionality effects in times of market stress.

Keywords: Credit risk, Optionality, Momentum, Bear market states, Financial crisis, trading strategy

JEL Classification: G12, G14