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Authors: Zaremba, Kambouris
Title: The Sources of Momentum in International Government Bond Returns
This study aims to offer a new explanation for the momentum effect in international government bonds. Using cross-sectional and time-series tests, we examine a sample of bonds from 22 countries for the years 1980 through 2018. We document significant momentum profits that are not attributable to bond-specific risk factors, such as volatility or credit risk. The global bond momentum is driven by the returns on underlying foreign exchange rates. Controlling for currency movements fully explains the abnormal returns on momentum strategies in international government bonds. The results are robust to many considerations including alternative sorting periods, portfolio construction methods, as well as subperiod and subsample analysis.
Notable quotations from the academic research paper:
"The various types of momentum effects have also been documented in government bonds, implying that the fixed-income winners outperform fixed-income losers. Although the finance literature extensively discusses the sources of momentum in an equity universe, the specific explanations for momentum in government bonds are rather scarce.
This paper aims to contribute in two ways. First, we provide new evidence on the momentum effect in international government bond markets. Using cross-sectional and time-series tests, we investigate a sample of government bonds from 22 countries for the years 1980 through 2018.
Second, and more importantly, we offer and test two new explanations of momentum. Our first hypothesis builds on Conrad and Kaul (1998): we conjecture that the momentum in bonds may simply capture the cross-sectional variation in long-run returns. In other words, the top performing assets continue to deliver higher returns because they exhibit excessive risk exposure. In particular, we assume that the winner (loser) bonds may display high (low) exposure to duration and credit risks, which drive the excessive long-run returns. The second hypothesis is that the momentum in bonds might be driven by the returns on underlying currencies.
The primary findings of this study can be summarized as follows. We document a strong and robust momentum effect in government bonds. An equal-weighted portfolio of past winners tends to outperform past losers by 0.24–0.35% per month. The effect is not fully attributable to the risk factors in government bonds, which explain 38–55% of the abnormal profits. Nevertheless, the phenomenon is entirely explained by the momentum in underlying foreign exchange rates, which is consistent with our second hypothesis. Once we control for the currency returns in cross-section or time-series tests, the momentum alphas disappear. The results are robust to many considerations, including alternative sorting periods and portfolio implementation methods, as well as subperiod and subsample analyses."
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