Contrarian and Momentum Investment Strategies in Pakistan Stock Exchange

Abstract

In this study, we examine several aspects of the momentum strategies such as profitability, risk-based explanation, and decomposition of the momentum profits. For this purpose, we use weekly and monthly data of 581 firms listed at the Pakistan Stock Exchange (PSX) for the period 2004-2014. We found the presence of momentum profits over short- and long-horizons, while majority of the contrarian profits were observed only in the presence of penny stocks that have share prices of PKR 10 or less. As a robustness check, we computed returns through weighted relative strength scheme and average cumulative abnormal returns. Interestingly, both the methods have shown a similar pattern in returns. Further, to know which factor contributes more to momentum and contrarian profits, we used the model proposed by Lo and MacKinlay (1990). Our findings show that the overreaction effect is the largest contributing factor of contrarian profits in PSX, while cross-sectional risk is the second largest factor. Moreover, the lead-lag effect contributes positively to the contrarian profits. Similarly, the largest contributing factor for momentum profits is the underreaction effect whereas cross-sectional risk is the second largest factor that positively affects momentum profits. Unlike contrarian profits, lead-lag effect reduces the momentum profits in the PSX.