Enhancing Momentum Investment Strategy Using Leverage

Forner,C., Muradoglu, Y.G. and Sivaprasad, S. 2018. Enhancing Momentum Investment Strategy Using Leverage. Journal of Forecasting. 37 (5), pp. 573-588. doi:10.1002/for.2522

TitleEnhancing Momentum Investment Strategy Using Leverage
AuthorsForner,C., Muradoglu, Y.G. and Sivaprasad, S.
Abstract

Previous studies examine investment strategies based on leverage and momentum; none investigate both variables jointly as an investment strategy. This paper is the first incorporating leverage and momentum together. We show that low past returns (losers) forecasts future negative abnormal returns only among stocks with high leverage levels, but not among stocks with low leverage levels. However, high past returns (winners) forecasts future positive abnormal returns independently of leverage level. As result, the negative relation between leverage and future abnormal returns is only observed among loser stocks and the positive relation between past returns and future abnormal returns is only shown among non-winner stocks. Our results are important to achieve better investment strategies: buying winners stocks (independently of their level of leverage) and short-selling losers stocks with high leverage yield higher abnormal returns than strategies based in only one of these variables. Our two-dimension strategy yields risk adjusted abnormal returns of 15.66% per annum, while the single leverage or momentum strategies yield 7.70% and 7.96% per annum respectively. The difference is nearly 8% and economically significant. If leverage is considered as proxy for default risk, our results, contrary to previous evidence, show that momentum profits are not exclusive of default stocks, nor momentum returns are only driven by negative returns yielded by distress stocks.

Keywordsleverage, momentum, investment strategy, distress stocks, non-regulated industries
JournalJournal of Forecasting
Journal citation37 (5), pp. 573-588
ISSN1099-131X
Year2018
PublisherWiley
Digital Object Identifier (DOI)doi:10.1002/for.2522
Publication dates
Published online26 Mar 2018
Published26 Mar 2018
Published in printAug 2018

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