Capital structure and momentum strategies

Abstract

Purpose The paper aims to investigate whether or not a firm’s capital structure can interact with past stock returns to affect future stock returns. Specifically, the authors examine whether or not capital structure can help improve momentum profit. Design/methodology/approach The authors use the US common stocks data from 1965 to 2022 to empirically examine the impact of capital structure on momentum profit. Findings When capital structure is measured either as the ratio of debt to asset or the ratio of liability to asset, we all find out that momentum strategies tend to be more profitable for stocks with large capital structure. Originality/value Besides documenting the empirical evidence of the impact of capital structure on momentum profit, the authors also present a simple explanation for their empirical results and show that their finding is consistent with the behavioral finance theory that characterizes investors’ increased psychological bias and the more limited arbitrage opportunity when the estimation of firm value becomes more difficult or less accurate.