Studying the relationship between default risk and momentum effect: based on evidence from firms listed on Tehran stock exchange

Subject Areas : Financial Knowledge of Securities Analysis

Mir Feiz  Fallah Sham ¹ (Associate Professor and Faculty Member, Islamic Azad University Central Tehran Branch, Tehran, Iran.)
Maysam  Ahmadvand ² (Ph.D Student in Finance, Allameh Tabatabaei University, Tehran, Iran)
Hadi  Khajezadeh Dezfuli ³ (Ph.D Student in Finance, Allameh Tabatabaei University, Tehran, Iran.)

Received: 2016-03-08 Accepted : 2016-06-25 Published : 2018-03-21

Keywords: Momentum effect, Default risk, Black-Scholes-Merton (BSM) Opt, Behavioral Finance, Tehran Stock Exchange,

Abstract :

This paper analyzes the role of default risk in the momentum effect focusing on data from Tehran stock exchange during 19/04/2009-21/07/2015. Default risk was calculated by a measure based on the Black-Scholes-Merton (BSM) option pricing model, where a firm’s default risk is derived from the market prices of its shares. This method overcomes some of the problems associated with the default risk measures used in prior studies. To describe momentum effect, by determining the formation period to be 6 months, and the holding period to be 3, 6, or 12 months, we firstly examined the profitability of short term (3/6), midterm (6/6), and long term (12/6) momentum strategies and found that during abovementioned time period, only midterm momentum strategy is profitable. Then, we showed there is no relationship between default risk and momentum effect. While the loser portfolio is characterized by high default risk, small size, high book-to-market ratio and illiquidity, characterization of the winner portfolio is somewhat more complex. This makes momentum profits difficult to forecast.

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