83 Pages Posted: 9 Aug 2016 Last revised: 16 Dec 2016
Date Written: November 15, 2016
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: 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