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Time-Varying Expected Momentum Profits
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.
   
Keywords Momentum; Time-varying expected returns; Markov switching regression model; Business cycle; Procyclicality; Growth options
   
Citation Min, B. K. (2014). Time-Varying Expected Momentum Profits. Journal of Banking and Finance, 49, 191-215.
   
Type Journal article (English)
Date of appearance 1-12-2014
Journal Journal of Banking and Finance
Volume 49
Pages 191-215