Testing the growth option theory: the profitability of enhanced momentum strategies in Australia

Abstract

Recent literature relates growth option theory to various return regularities. Sagi and Seasholes (2007) (S&S) develop a model that explains momentum profitability using growth option theory. We test the model's predictions in the Australian market by examining three momentum strategies. Two of these strategies examine the profitability of momentum strategies conditioned on stocks characteristics, whereas the third conditions on previous market returns. Our results are largely supportive of the S&S model. As predicted by S&S, the two strategies that use firm-specific characteristics yield a higher profit than a simple momentum strategy. The third strategy that conditions on the previous market return also leads to differences in momentum profitability between bull and bear markets, but these differences are small and largely insignificant.

Australian momentum: performance, capacity and the GFC effect

“…In these models, profits accruing to momentum strategies are generally attributed to cross‐sectional differences in expected returns due to risk (Conrad and Kaul, ; Berk et al ., ; Chordia and Shivakumar, ; Johnson, ; Park and Kim, ). There is also evidence from four developed European stock markets (France, Germany, Spain and the UK) that momentum returns are not due to default risk (Abinzano et al ., ), and evidence that momentum profitability may be modelled by growth option theory (Aharoni et al ., ).…”

Testing relationships between firm size and perceptions of growth and profitability: An investigation into the practices of Australian ICT SMEs

“…Firm growth studies in Australia have been previously focussing on the stages (McMahon, 1998; and process of growth (Snooks, 1973;Mankelow, 2007), the factors of growth (Wijewardena & Tibbits, 1999), growth strategies (Aharoni, Ho & Zeng, 2012) growth and profitability (Davidsson et al, 2009;Fitzsimmons, Steffens & Douglas, 2005), productivity growth (Wadud, 2007) and other aspects of growing firms, such as training and learning (Jones, 2012). The profit-growth nexus specifically has not been investigated thus far, opening up the avenue for this study.…”