Related Securities and the Cross-Section of Stock Return Momentum: Evidence From Credit Default Swaps (CDS)
98 Pages Posted: 2 Jun 2016 Last revised: 8 Aug 2018
Date Written: May 9, 2018
We document that stock return momentum strategies earn 20% more per year among firms with strong alignment in their past equity and credit returns than firms with diverging returns across these two markets. Using structural Q-theory, we show information in both equity and credit from the full liability side of a firm’s balance sheet reveals unobserved asset return momentum that explains cross-sectional variations in stock return momentum. We complement this rationale with limited arbitrage in equity and credit markets to further explain our findings during financial market dislocations. We also show that multi-market related securities signals hedge stock momentum crashes.
Keywords: Related securities, stock return momentum, momentum crashes, credit default swaps, multi-market momentum signals, aligned/misaligned momentum, asset return momentum, asset substitution, limits to arbitrage, crash risk management.
JEL Classification: G12, G14
Suggested Citation: Suggested Citation