Long-term Return Reversal Research Articles

Overnight returns and investor sentiment: Further evidence from the Taiwan stock market

This study reexamines the relationship between overnight returns and investor sentiment—a finding documented by Aboody et al. (2018, JFQA)—on the Taiwan Stock Exchange (TWSE). We aim to verify whether the overnight returns on the TWSE are reflective of investor sentiment and clarify how the trading activities of different investor types affect the patterns of overnight returns. We show that overnight returns cause short-term persistence and long-term return reversal on the TWSE, both of which are driven by investor sentiment. In addition, the percentage of retail trading enhances the patterns of overnight returns. A high individual trading volume ratio raises the tendency of short-term overnight return persistence. Our findings provide further support for the validity of overnight returns in measuring investor sentiment. When overnight returns fail to work as a valid sentiment proxy in many non-US markets, their success on the TWSE suggests that the connection with the US market, the preference of investors for chasing information, and the structure of market participants are likely to be the most important determinants of whether they are reflective of investor sentiment.

The Momentum Strategies and Salience: Evidence from the Korean Stock Market

ABSTRACT This study compares momentum strategies based on traditional, idiosyncratic, rank, and sign momentum measures in the Korean stock market. We find that the traditional momentum strategy underperforms and suffers long-term return reversals, while other strategies (idiosyncratic, rank, and sign) exhibit stable profits. We employ a direct measure of salience and suggest that the unprofitability of the traditional momentum strategy in the Korean market can be explained by the salience effect. We further show that the traditional momentum strategy can be profitable after excluding stocks with salient payoffs in the formation period.

Non-parametric momentum based on ranks and signs

Abstract This study proposes alternative momentum strategies built on the rank and sign of daily returns. Rank and sign momentum strategies are robust to the presence of extreme price movements. They generate significant profits for short-term holding periods and exhibit no long-term return reversals. More importantly, they subsume traditional price momentum, but not vice versa. In addition, rank and sign momentum strategies experience much weaker momentum crashes. Further evidence indicates that rank and sign momentum profitability is less vulnerable to salient past returns while traditional price momentum winners (losers) tend to be overvalued (undervalued) when they face a higher degree of salience.

Return reversal effect in Shanghai A share market

PurposeThe existing literature about return reversal effect in Chinese stock markets is inconclusive and controversial. Therefore, the purpose of this paper is to investigate the presence of return reversal effect in the Shanghai A stock market.Design/methodology/approachThe authors used the late-stage contrarian strategy of Malin and Bornholt (2013) for the period March 2011‒March 2016.FindingsThe results show that there is a long-term return reversal effect in the Shanghai A stock market for the period March 2011‒March 2016. When portfolios are in the formation period (P=24 months), the excess returns are significant in the holding period, Q=6, 9, 12, 24 months. Further, there is also a significant short-term momentum effect in the Shanghai A stock market. For the robustness check, a new reversal factor was introduced into the Fama‒French three-factor model. Results show that portfolios have a smaller size and have lower book-to-market ratios; the return reversal factor explains a portion of the abnormal returns and coefficient of the reversal effect is significant.Research limitations/implicationsThe authors caution readers from generalizing the findings of this study, as the sample is small and the focus is only on A stocks listed on the Shanghai Stock Exchange.Originality/valueThe present research expands the current literature by providing a comprehensive information about the presence of the long-term and short-term return reversal effects in Shanghai A stock market. Furthermore, the Chinese stock markets have distinctive features in comparison to the developed stock markets in terms of government control, institutional structure, liquidity, cultural background, etc. Such differences affect the pattern in stock returns compared with those observed in developed stock markets. Contrary to previous studies, the present study also accounts for robustness checks. Finally, it also evaluates the possible reasons for the return reversal effect in the Shanghai market.

Momentum and reversals: Are they really separate phenomena?

The literature has long debated the co-existence of intermediate-term momentum and long-term return reversals. Recent studies propose several theories to isolate momentum from reversals. This paper provides comprehensive analyses to examine whether intermediate-term momentum and long-term return reversals are really separate phenomena. We show that although these theories all capture a significant fraction of stock returns, the standard Jegadeesh–Titman momentum strategy still generates significant profits in the intermediate term, which are followed by long-term reversals after controlling for these alternative effects. Thus, the co-existence of intermediate-term momentum and long-term reversals remains a distinct phenomenon that is independent of recent theories.

Consumption growth predictability and asset prices

Abstract We derive and test a consumption-based intertemporal asset pricing model in which an asset earns a risk premium if it performs poorly when expected future consumption growth deteriorates. The predictability of consumption growth combined with the recursive preference delivers news about future consumption growth an additional risk factor, in addition to news about current consumption growth. We model the consumption growth dynamics using a vector autoregressive (VAR) structure with a set of instrumental variables commonly used for forecasting future economic growth. Our VAR estimation provides strong empirical support for future consumption growth predictability. The cross-sectional test shows that the model explains reasonably well the dispersion in average excess returns of 25 portfolios sorted on size and book-to-market, as well as 25 portfolios sorted on size and long-term return reversal. Growth stocks and long-term winners underperform value stocks and long-term losers, respectively, because growth stocks and long-term winners hedge adverse changes in the future consumption growth opportunities.

Wage Growth and Equity Risk Premia

We develop a simple three-factor consumption-based asset pricing model that includes wage growth as a risk factor, and evaluate whether the model explains six major CAPM anomalies: book-to-market, investment, operating profitability, long-term return reversal, net share issues, and residual variance. Wage growth arises in the pricing kernel by using a non-separable utility over consumption and leisure, and represents the growth in the opportunity cost of enjoying leisure hours. In the model, wage growth earns a negative price of risk, that is, higher wage growth leads to a decline in leisure demand, which increases the marginal utility of consumption for an investor with risk aversion above one. The empirical cross-sectional tests show that the model explains around 50% of the cross-sectional dispersion in average returns of the joint six CAPM anomalies (160 equity portfolios). Further, the proposed model compares favorably with alternative return-based multifactor models widely used in the literature. The risk price estimates for wage growth are significantly negative, while the implied preference parameter (share of leisure) estimates are economically plausible in most cases. Overall, our results suggest that aggregate wage growth can help explaining cross-sectional equity risk premia.

Skewness Preference and IPO Anomalies in China

Due to investors’ unique structure and new transaction share rules, speculation in China’s IPO market prevails. In this paper, we investigate many anomalies in IPOs, concluding huge initial return, long-term return reversal and high turnover rate from the perspective of investors’ desire to gamble (skewness preferences). Based on Cumulative Prospect Theory, this paper theoretically and empirically verified that there is a significant impact on the first day and the long-term returns. Using all issued IPO between 2009 and 2012 as a study sample, the empirical results show that the increase of a standard deviation of skewness preference, and the first day returns increase 5.5%. Moreover, when the market environment is favorable, the positive sentiment of investors will make the effect of skewness preferences stronger. In the long run, the stronger the expected skewness is, the more negative the long-term risk premium is, and the lower the possibility of new shares that institutional investors continue to hold. In addition, skewness preferences across different industries, different financing scale, and different issue price has a significant difference.

Dynamic Risk Premia and Asset Pricing Puzzles

I apply a simple and intuitive econometric method to extract dynamic risk premia from the Fama-French (2015) multifactor asset pricing model. With all of the Fama-French (2015) state variables, this analysis is the first exploration of whether the pervasive asset pricing anomalies persist after the econometrician accounts for the time variation in multifactor risk premia. The ubiquitous anomalies of size, value, momentum, investment, profitability, short-term return reversal, and long-term return reversal, disappear after the econometrician takes into account the dynamic nature of multifactor risk premia. The prior linear empirical asset pricing models arise as special cases of this dynamic multifactor model. The main contribution of the current paper relates to the design of a workhorse model in the asset pricing literature. The previous linear empirical asset pricing models can be viewed as special cases of this more general dynamic multifactor model. This dynamic multifactor model carries important implications for equity cost estimation, corporate event assessment, financial risk management, and mutual fund performance evaluation. My dynamic analysis of multifactor risk premia from the Fama-French (2015) five-factor model proposes raising the hurdle for the conventional asset pricing tests. This recommendation serves as the time-series equivalent to the cross-sectional thesis of Harvey, Liu, and Zhu (2015).

Long-term industry reversals

This study investigates whether, how and why industry performance can drive long-term return reversals. Using data from the UK, we find that firms in losing industries significantly outperform those in winning industries over the subsequent five years. These industry reversals remain strong and persistent after controlling for stock momentum, industry momentum, seasonal effects and traditional risk factors. We find a strong influence of past industry performance on stock return reversals. Our results also show that past industry performance is the driving force behind long-term reversals. Specifically, we find that industry components drive stock reversals, while past stock performance does not explain industry reversals. Further analysis suggests that industry reversals are present in both good and bad states of the economy and are stronger in industries with high valuation uncertainty. This implies that industry reversals are more likely to be a result of mispricing. Key words: contrarian performance, industry, long term

Skewness Preference and IPO Anomalies in China

Due to investors' unique structure and new transaction share rules, speculation in China's IPO market is common. In this paper, we investigate many anomalies in IPOs that produce huge initial return, long-term return reversal and high turnover rate from the perspective of investors' desire to gamble (skewness preferences). Based on Cumulative Prospect Theory, this paper theoretically and empirically verified that there is a significant impact on first day and long-term returns. Using all issued IPO between 2009 and 2012 as a study sample, the empirical results show that the increase of a standard deviation of skewness preference, and the first day returns increase 5.478%. Moreover, when the market environment is favorable, the positive sentiment of investors will make the effect of skewness preferences stronger. In the long run, the stronger the expected skewness is, the more negative the long-term risk premium is, and the lower the possibility of new shares that institutional investors continue to hold. In addition, skewness preferences across different industries, different financing scale, and different issue price has a significant difference.

Industry Long-Term Return Reversal

Given that extreme industry returns may herald long-term structural changes in the industries involved that may eventually lead to reversals in industry fortunes, we investigate the evidence for long-term return reversal in industry returns. Our study employs both pure contrarian strategies and late-stage contrarian strategies, and includes extra-long strategy formation periods (up to 132 months) to allow sufficient time for structural changes to begin. We find strong evidence of reversals in the long-term returns of industries. These reversals continue for many years (with valuation effects observed up to ten years after commencement) and are difficult to reconcile with overreaction.

Industry long-term return reversal

Given that extreme industry returns may herald long-term structural changes in the industries involved that may eventually lead to reversals in industry fortunes, we investigate the evidence for long-term return reversal in industry returns. Our study employs both pure contrarian strategies and late-stage contrarian strategies, and includes extra-long strategy formation periods (up to 132 months) to allow sufficient time for structural changes to begin. We find strong evidence of reversals in the long-term returns of industries. These reversals continue for many years (with valuation effects observed up to 10 years after commencement) and are difficult to reconcile with overreaction.

On the Role of Intangible Information and Capital Gains Taxes in Long-Term Return Reversals

Prior studies have linked long-term reversals to the magnitude of locked-in capital gains suggesting that reversals are driven by tax effects and not overreaction. I find that locked-in capital gains do not explain the reversals in winners when winner returns are based on intangible information. In fact, the reversals for intangible return winners are long lasting and robust to controls for growth in assets and capital expenditures. To the extent that reversals associated with intangible information stem from investors’ overreaction to intangible information and given the prior results linking reversals only to intangible information, my results suggest that overreaction still explains reversal patterns in US stock returns.

Long-term return reversal: Evidence from international market indices

This paper documents evidence of reversals in the long-term returns of international equity markets. We use recent short-term performance to better select contrarian securities that appear ready to reverse. Our late-stage contrarian strategy consistently provides stronger evidence of long-term return reversal than does the traditional pure contrarian strategy when applied to developed and emerging market indices. Despite an absence of cross-sectional contrarian profits for developed markets in our post-1989 subsample, longitudinal analysis provides strong evidence of reversals during this period. Overall, our results suggest that the reversal of long-term returns may be stronger and more pervasive than is generally understood.

On the Role of Intangible Information and Capital Gains Taxes in Long-Term Return Reversals

Prior studies have linked long-term reversals to the magnitude of locked-in capital gains, suggesting that reversals are driven by tax effects and not overreaction. We show that locked-in capital gains do not explain the reversals in winners when winner returns are based intangible information (Daniel and Titman, 2006). In fact, the reversals for intangible return winners are long-lasting and robust to controls for growth in assets and capital expenditures. To the extent that reversals associated with intangible information stem from investors’ overreaction to intangible information, and given prior results linking reversals only to intangible information, our results suggest that overreaction still explains reversal patterns in US stock returns.

Long-Term Return Reversal: Evidence from International Market Indices

This paper documents evidence of reversals in the long-term returns of international equity markets. We use recent short-term performance to better select contrarian securities that appear ready to reverse. Our late-stage contrarian strategy consistently provides stronger evidence of long-term return reversal than does the traditional pure contrarian strategy when applied to developed and emerging market indices. Despite an absence of cross-sectional contrarian profits for developed markets in our post-1989 subsample, longitudinal analysis provides strong evidence of reversals during this period. Overall, our results suggest that the reversal of long-term returns may be stronger and more pervasive than is generally understood.

Too Good to Ignore? A Primer on Listed Penny Stocks

This paper identifies distinct characteristics of U.S. penny stocks listed on NYSE, AMEX, and NASDAQ. They are characterized by high return, high beta, small capitalization, high book-to-market ratio, high idiosyncratic volatility, and poor liquidity. The liquidity costs as measured by Gibbs effective transaction costs for penny stocks are more than twice as large as the magnitude of non-penny stocks. Abnormal returns of penny stocks estimated using the Fama-French (1993) three-factor model and the Carhart (1997) four-factor model become insignificant after additional risk factors capturing short- and long-term return reversals and liquidity risk introduced to the asset pricing model. Although abnormal returns are insignificant for the entire penny stocks in the context of the seven-factor model, zero-cost portfolios built on firm characteristics (such as firm size, value, momentum, and idiosyncratic volatility) yield significant profitability. Because these results are sensitive to portfolio weighting scheme (value vs. equal weight) and the lengths of holding periods, further analyses are warranted for trading strategies.

Long-term return reversals—Value and growth or tax? UK evidence

This paper examines (i) whether value-growth characteristics have more power than past performance in predicting return reversals; and (ii) whether typical rational behaviour such as incentives to delay paying capital gain taxes can better explain long-term reversals than past performance. We find that value-growth characteristics generally provide better explanations for long-term stock returns than past performance. The evidence also shows that winners identified by capital gains dominate past performance winners in predicting reversals in the cross-sectional comparison. However, in the time-series analysis, when returns on capital gain winners are adjusted by the Fama and French (1996) risk factors, the predictive power of capital gain winners disappears. Our results show that capital gain winners are heavily featured as growth stocks. Return reversals in capital gain winners potentially reflect market price corrections for growth stocks. We conclude that investors’ incentives to delay paying capital gain taxes cannot fully rationalise long-term reversals in the UK market. Our results also imply that the long-term return pattern potentially reflects a mixture of investor rational and irrational behaviour.

Enhancing Contrarian Strategies: Evidence from Developed Market Indices

A problem for contrarian strategies is that short-term continuation can offset long-term return reversal. This paper introduces a method for enhancing contrarian strategies to avoid this problem and applies it to 18 developed markets equity indices. Using recent short-term performance to determine which contrarian indices appear ready to reverse and which do not, we define late stage and early stage contrarian strategies. Late stage strategies are consistently more profitable than both pure contrarian and early stage contrarian strategies. Our subsample results confirm a general weakening in contrarian strategy profitability post-December 1989.