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Time-varying expected momentum profits

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  • Kim, Dongcheol
  • Roh, Tai-Yong
  • Min, Byoung-Kyu
  • Byun, Suk-Joon

Abstract

This paper examines the time variations of expected momentum profits using a two-state Markov switching model with time-varying transition probabilities to evaluate the empirical relevance of recent rational theories of momentum profits. We find that in the expansion state the expected returns of winner stocks are more affected by aggregate economic conditions than those of loser stocks, while in the recession state the expected returns of loser stocks are more affected than those of winner stocks. Consequently, expected momentum profits display strong procyclical variations. We argue that the observed momentum profits are the realization of such expected returns and can be interpreted as the procyclicality premium. We provide a plausible explanation for time-varying momentum profits through the differential effect of leverage and growth options across business cycles.

Suggested Citation

  • Kim, Dongcheol & Roh, Tai-Yong & Min, Byoung-Kyu & Byun, Suk-Joon, 2014. "Time-varying expected momentum profits," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 191-215.
  • Handle: RePEc:eee:jbfina:v:49:y:2014:i:c:p:191-215
    DOI: 10.1016/j.jbankfin.2014.09.004
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    More about this item

    Keywords

    Momentum; Time-varying expected returns; Markov switching regression model; Business cycle; Procyclicality; Growth options;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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