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Investment strategies based on both leverage and momentum provides enhanced profits, according to new study.
Previous studies on investment strategies have shown that higher returns on investment can be made only by taking high levels of risk. A new study, the first of its kind, brings together two asset pricing features: returns to low leverage firms and continuation of prior returns. Earlier studies do not consider momentum and likewise, studies on momentum do not consider leverage. The analysis has shown that by using a combined investment strategy incorporating both leverage and momentum, it is possible to make excess returns.
Gulnur Muradoglu, Professor of Finance at Queen Mary’s School of Business and Management, was one of the lead authors of the paper. Professor Muradoglu explained: “We show that investing in less risky low leverage firms yields higher returns. If this is combined with firms with price momentum it results in even higher returns”.
The study shows that negative excess returns (once risks are priced) are exclusive for loser stocks (where price has decreased) that have high leverage ratios. Loser stocks with low leverage ratios were found to overcome poor performance. Positive abnormal returns were found in all winner stocks independently of their leverage level.
Professor Muradoglu added: “We show that an investment strategy that buys winners stocks, independently of their leverage level, and short-sell loser stocks with high leverage yields adjusted returns of almost 16 per cent annually. This is statistically and economically higher than that of the single leverage strategy, both of which yield around eight per cent annually”.
The analysis concludes that using investment strategies which incorporate both leverage and momentum results in almost double the yield than strategies that did not use a combined approach.
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