Default probability anomalies in the momentum strategies

This study examines the usefulness of default probability (<italic>DP</italic>) in explaining momentum profits. We follow Merton (1974) in computing the <italic>DP</italic> and then follow Jegadeesh and Titman (1993) in conducting default momentum investing. We consider emerging Taiwanese stock market and divide its stocks into three <italic>DP</italic> groups. Our findings show that adding <italic>DP</italic> to momentum investing leads to an increase in momentum profits, suggesting that momentum pay-off increases as <italic>DP</italic> increases. Moreover, a significant and positive momentum profit of buying winners in the high-<italic>DP</italic> group and selling losers in the low-<italic>DP</italic> group is observed, implying that <italic>DP</italic> anomalies exit in momentum strategies. These findings shed light on the source of profitability of momentum strategies.