Is default risk the hidden factor in momentum returns? Some empirical results

type="main" xml:id="acfi12021-abs-0001" xml:lang="en"> <title type="main">Abstract</title> <p>This paper analyzes the role of default risk in the momentum effect focusing on data from four developed European stock markets (France, Germany, Spain and the United Kingdom). Using a market-based measure of default risk, we show that it is not the hidden factor behind this effect. While the loser portfolio is characterized by high default risk, small size, high book-to-market and illiquidity, characterization of the winner portfolio is somewhat more complex. Given that the momentum strategy is the return differential between the winners and the losers, factors such as the stock market cycle or the evolution of momentum portfolios against their reference point make momentum profits difficult to forecast.