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Does Financial Distress Risk Drive the Momentum Anomaly?

Authors

  • Vineet Agarwal,

    1. Vineet Agarwal is a Lecturer at the Cranfield School of Management, Bedford, UK.
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  • Richard Taffler

    1. Vineet Agarwal is a Lecturer at the Cranfield School of Management, Bedford, UK.
    2. Richard Taffler is the Martin Currie Professor of Finance and Investment at the Management School, University of Edinburgh, Edinburgh, UK.
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  • This paper has benefited, in particular, from the comments of the anonymous referee as well as, among others, Michael Boldin, Jonathan Crook, Weimen Liu, Craig Nicholls, Norman Strong, and Sudi Sudarsanam, and participants at the annual meetings of the Financial Management Association, American Accounting Association, European Financial Management Association, British Accounting Association, and INQUIRE UK, and research seminars held at Lancaster University, University of Manchester, and Cass Business School.

Abstract

This paper brings together the evidence on two asset pricing anomalies—continuation of prior returns (momentum) and the market mispricing of distressed firms—using UK data. Our analysis demonstrates both these effects are driven by market underreaction to financial distress risk. In particular, we find momentum is proxying for distress risk, and is largely subsumed by our distress risk factor. We also find, as with US studies, no evidence that size and book-to-market (B/M) effects in stock returns are linked to financial distress.

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