Testing the growth option theory: the profitability of enhanced momentum strategies in Australia


  • We particularly thank Christine Brown, Bruce Grundy, Norman Strong, Martin Walker, an anonymous referee and Robert Faff (the Editor) for their helpful comments. We also thank Ben Marshall and Terry Walter for kindly providing the Approved Securities data, part of which we used to collect the Australian Stock Exchange firm list. We are appreciative of the effort of George Wang who helps us collect the data. Remaining errors are ours.


Recent literature relates growth option theory to various return regularities. Sagi and Seasholes (2007) (S&S) develop a model that explains momentum profitability using growth option theory. We test the model’s predictions in the Australian market by examining three momentum strategies. Two of these strategies examine the profitability of momentum strategies conditioned on stocks characteristics, whereas the third conditions on previous market returns. Our results are largely supportive of the S&S model. As predicted by S&S, the two strategies that use firm-specific characteristics yield a higher profit than a simple momentum strategy. The third strategy that conditions on the previous market return also leads to differences in momentum profitability between bull and bear markets, but these differences are small and largely insignificant.