Related Securities and the Cross-Section of Stock Return Momentum: Evidence From Credit Default Swaps (CDS)

83 Pages Posted: 9 Aug 2016 Last revised: 16 Dec 2016

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

Multiple version iconThere are 2 versions of this paper

Date Written: November 15, 2016

Abstract

We document that related securities linked through firm fundamentals provide important cross-market return performance information. During 2003-2015, we find significantly stronger stock return momentum for entities whose past stock and CDS returns are in congruence versus entities whose past stock and CDS returns disagree. A dynamic stock trading strategy based on this cross-sectional performance differential earns an annualized alpha of nearly 18% with a Sharpe ratio of 1.37, avoids crash risk, and is robust to out-of-sample tests using international stocks. Relative pricing of credit across related securities explains, in part, the cross-section of stock return momentum.

Keywords: Related securities, CDS market, stock return momentum, CDS momentum, joint/disjoint momentum, momentum crashes, relative pricing of credit, capital structure arbitrage, market segmentation, stock market efficiency, international momentum

JEL Classification: G12, G14

Suggested Citation

Lee, Jongsub and Naranjo, Andy and Sirmans, Stace, Related Securities and the Cross-Section of Stock Return Momentum: Evidence From Credit Default Swaps (CDS) (November 15, 2016). Available at SSRN: https://ssrn.com/abstract=2819774 or http://dx.doi.org/10.2139/ssrn.2819774

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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