Overcoming Arbitrage Limits: Option Trading and Momentum Returns

Abstract:

 with Abhay Abhyankar, Ilias Filippou and Ozkan Haykir

Returns to cross-sectional momentum in the U.S. equity market, over 1996-2016, are fifty percent lower and statistically insignificant relative to the previous two decades. The decline is linked to larger arbitrage capital flows, lower stock trading costs, and greater investor awareness after publication. During this period stocks with traded options rose to more than seventy percent of all listed stocks. We find strong evidence that the reduction in momentum profits is also related to stock option trading that offers alternate avenues for short sales and information flows that contribute to more efficient stock pricing.

Presented at :

2nd World Symposium on Investment Research 2019* (New York, US) , Eastern Finance Association 2019 (Miami, US), NOVA Business School (Lisbon, scheduled), SAEe 2018 (Madrid, Spain); NFA conference 2018 (Quebec, Canada) , Finance Forum 2018 (Santander, Spain)

Keywords: Momentum returns, stock option trading, short-sale constraints.

JEL Classification: G11, G12, G14, G32.

*Presented by co-authors.