Theses Doctoral

Can Cash Flow Expectations Explain Momentum and Reversal

Lu, Zhongjin

This dissertation delves into the relation between asset returns, risks, and cash flow expectations. The first chapter uses the model-implied patterns of cash flow expectations to differentiate among the three most prominent behavioral theories explaining stock return momentum and reversal. Using analyst earnings forecasts as a proxy for cash flow expectations, I trace the dynamics of the expectation errors for winner and loser stocks in a 24-month holding period, during which returns are characterized by a momentum phase followed by a reversal phase. The large positive cross-sectional difference in expectation errors between winner and loser stocks gradually shrinks to zero over the holding period. This pattern is most consistent with the underreaction hypothesis in Hong and Stein (1999), in which cash flow expectation errors can only explain momentum, and price extrapolation is needed to explain reversal.
The second chapter examines carry trade returns formed from the G10 currencies. Performance attributes depend on the base currency. Spread-weighting and risk-rebalancing positions over time improve performance. Hedging with options reduces profitability. Equity, bond, FX, and volatility risks cannot explain profitability. Time-varying dollar exposure produces abnormal excess returns. Dollar-neutral carry trades exhibit insignificant abnormal returns, while the dollar exposure part of the carry trade earns significant alphas and little skewness. Downside equity market betas of carry trades are not significantly different from unconditional betas. Distributions of drawdowns and maximum losses from daily data indicate the importance of autocorrelation in determining the negative skewness of longer horizon returns.
The third chapter investigates the question of whether sovereigns pay a premium on their own borrowing as a result of (implicitly or explicitly) guaranteeing sub-entities' debt has been explored only little. We use an event study approach with separate equations for two levels of government to test for a simultaneous increase in sovereign risk premia and decrease in sub-national risk premia--or a de facto transfer of risk from the latter to the former--on the day a sovereign bailout is announced. Using daily financial market data for Spain and its autonomous regions from January 2010 to June 2013, we find support for our risk transfer hypothesis. We estimate that the Spanish sovereign's spread may have increased by around 70 basis points as a result of the central government's support for fiscally distressed comunidades autónomas.



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More About This Work

Academic Units
Thesis Advisors
Hodrick, Robert J.
Ph.D., Columbia University
Published Here
July 7, 2014