Past Losers Research Articles

Contrarian investment strategy with data envelopment analysis concept

One of the typical issues in financial literature is that the market tends to be overly pessimistic about value stocks, many of which are past losers. Therefore, over-reactions might capture by measuring earnings surprise vary with past return levels. In this paper, we propose a new index for an effective investment strategy to capture the return-reversal effect using both Data Envelopment Analysis (DEA) and Inverted DEA in order to consider the above characteristics of the market. Our investment strategy using the new index exhibits better performance than the naive return-reversal strategy that only uses past returns or earnings surprise. In addition, the correlations between our new index and commonly used value indices are insignificant, and the value indices cannot represent the over-valued (under-valued) situations perfectly. Hence, considering both proposed and value indices like book-to-price one, we could select value stocks more effectively than by using only one of these indices.

Profitability of Contrarian Strategies: Evidence from the Istanbul Stock Exchange*

ABSTRACTThis study examines the momentum and contrarian effects on stock returns in one of the leading emerging markets, which has a unique market structure, with record‐high inflation, high volatility, high turnover, low correlation of returns with other exchanges and myopic investors: the Istanbul Stock Exchange (ISE). It also investigates the weak‐form efficiency of the stock market by examining the profitability of a number of contrarian strategies based on past returns, size, price, book‐to‐market and earnings‐to‐price ratios of stocks in various lengths of formation and holding periods. Our findings show that a self‐financing trading strategy, buying past loser stocks and selling past winner stocks generate significant abnormal returns (approximately 15% annually) in ISE. However, these large contrarian profits are for bearing the extra risk of loser stocks similar to the US results. We also find significant price, size, and B/M effects in stock returns. Finally, our results show the continous profitability of contrarian strategies both in very short (starting from 1 month) and in long holding periods (up to 36 months), which appears to be related to country‐specific factors.

Short-Term Persistence in Mutual Funds Performance: Evidence from India

In this paper, we examine if there is any short-term persistence in mutual funds performance in the Indian context. We find no evidence that confirms persistence using monthly data. Using daily data, we observe that for fund schemes sorted on prior period four-factor abnormal returns, the winners portfolio does provide gross abnormal returns of 10% per annum on post-formation basis. The economic feasibility of zero-investment trading strategies that involve buying past winners and selling past losers is however in doubt. This is owing to the fact that these strategies generate low gross returns and that the winners portfolios involve higher investment costs than losers portfolios, thus destroying a major portion of extra-normal returns. Our empirical findings are consistent with the efficient market hypothesis and have implications for hedge funds and other managed portfolios who rely on innovative investment styles, including the fund of funds trading strategies that implicitly assume short-term persistence.

Return Differences Between Family and Non-Family Firms: Absolute and Index Differences

The objective of the paper is to determine if family firms are able to provide a return premium compared to their non-family counterparts. The assumption is that some of the benefits and costs related to family ownership can be absorbed into the business model. This may mean that family characteristics could actually impact the perception of the market and in turn affect their returns. We test this by using a unique sample of 152 family firms and matching them with non-family firms on the basis their sector, stock market index and size. Three models - CAPM, Fama-French 3-factor model and Carhart model - are used to test a trading strategy, i.e. buying family firms and selling short non-family firms, on the FTSE All Share, Fledgling and AIM Index. The results showed that the strategy is able to generate an abnormal profit for the firms on the FTSE All Share and Fledgling but fails to do so on the AIM in the presence of the 'momentum' factor-mimicking portfolio. It is far more profitable to use a trading strategy of buying past winners and selling short past losers on the AIM. We further investigate into the factors that drive the returns of family and non-family firms. Using factors related to risk, price-level, liquidity and growth-potential, we find that family firm returns are driven by their growth potential where as non-family firms' need to balance their risk in order to increase returns. A similar application on the 3 indices mentioned above reveals that the AIM and the Fledgling index behave similarly but differ from the FTSE All Share portfolio of firms.

Profitability of Price Momentum Strategies

This article investigates the profitability of price-based momentum strategies in the Asian markets. The authors find that unrestricted momentum strategies are not profitable. Using the benchmark 6-month formation period/6 month holding period strategy, the authors find that although returns are in the expected direction (i.e., past winners outperform past losers), they are not statistically significant. In addition, the statistical significance is not improved when the authors control for size and country effects. Interestingly, fourteen of the sixteen trading strategies generate unexpected negative returns, suggesting that past losers outperform past winners. In ten of these fourteen cases, the returns generated are statistically significant. The authors9 results represent challenges to those researchers trying to reconcile within a unified framework short-term momentum and long-term overreaction in equity markets. <b>TOPICS:</b>Emerging markets, portfolio construction, technical analysis

Delisted Firms and Momentum Profits

I find that approximately 40 percent of the momentum profit is generated by firms that are delisted from the market during the holding period, although the proportion of these firms in the momentum portfolio is around 10 percent. Most of the delisting-profit is derived from bankrupt firms, while merged firms have a minor effect on the momentum profitability. I further show that ex ante, firms with high bankrupt risk exhibit a stronger negative momentum than the average past loser, while firms with high likelihood to be merged exhibit a weaker positive momentum than the average past winner. A trading rule based on this asymmetry yields an average profit that is 1.5 times higher than the standard price momentum profit.

Explaining momentum profits with an epidemic diffusion model

We show that information diffusion is a function of its dissemination and assimilation. Whereas dissemniation is a function of observable factors such as volume and price volatility, assimilation is dependent on unobservable factors such as the usefulness and reliability of information. We find that buying low volume (or low volatility) past losers and shortselling low volume (or low volatility) past winners generates a positive net return across the entire sample period and especially during bear markets. Second, buying high volatility past winners and shortselling high volatility past losers generates a positive net return, especially during bear markets.

Profiting from past winners and losers

This paper posits that information diffusion is a function of its dissemination and assimilation. Whereas dissemination is proportional to observable factors such as volume and price volatility, assimilation is dependent on unobservable factors such as the usefulness and reliability of information. It is found that buying low-volume (or low-volatility) past losers and shortselling low-volume (or low-volatility) past winners generates a positive net return across the entire sample period and especially during bear markets. In addition, buying high-volatility past winners and shortselling high-volatility past losers generates a positive net return, especially during bear markets.

Does the UK Stock Market Overreact? Some Further Evidence for Stock Market Efficiency

One of the central hypotheses of behavioural finance is that stock prices systematically overreact. The seminal study is DeBondt and Thaler (1985), which appears to show that past winners (stocks that have earned the highest positive abnormal returns during the pre-formation period) tend to exhibit negative abnormal returns during the post-formation period, and similarly that past losers (stocks that have earned the greatest negative abnormal returns during the pre-formation period) tend to exhibit positive abnormal returns during the post-formation period. Pre- and post-formation periods range from one year to five years. It is further reported that stocks that have 'overreacted' the most, i.e. where the pre-formation period is longer, and hence where the abnormal returns are more extreme, tend to exhibit a correspondingly greater 'correction' during the post-formation period. The ensuing debate has focussed mainly on whether the results can be explained by a risk-premium story. However, the question has also been raised as to whether the purported overreaction effect actually exists at all, or whether it is merely an artefact created by data or methodological biases. The present study addresses the second of these issues, by carrying out an overreaction study using a new survivorship and look-ahead bias-free database on the UK stock market, SFD Capital UK Fully Listed Version 2.1, and using both cumulative abnormal return and holding period return methodologies in computing long-term returns. Using cumulative abnormal returns largely corroborates the results of DeBondt and Thaler (1985), while using holding period returns finds no evidence of overreaction. It is argued that the main results of the paper provide further evidence for weak form efficiency in the UK stock market.

Losers, Winners, and Biased Trades

When faced with sequential information, consumers tend to fall prey to one of two well-known heuristics: the hot (or cold) hand and the gambler's fallacy. The authors relate these two traditionally separate heuristics to differences in accepting (buy) versus rejecting (sell) decisions. They identify trend length as a contextual moderating variable and show an asymmetry between buying and selling frames. When applied to a stock market context, a consistent finding is that consumers prefer to buy past winners and sell past losers even when neither should be preferred. This behavior violates the normative rule of buy low and sell high.

Does Risk Seeking Drive Stock Prices? A Stochastic Dominance Analysis of Aggregate Investor Preferences and Beliefs

We use various stochastic dominance criteria that account for (local) risk seeking to analyze market portfolio efficiency relative to benchmark portfolios formed on market capitalization, book-to-market equity ratio and price momentum. Our results suggest that reverse S-shaped utility functions with risk aversion for losses and risk seeking for gains can explain stock returns. The results are also consistent with a reverse S-shaped pattern of subjective probability transformation. The low average yield on big caps, growth stocks, and past losers may reflect investors’ twin desire for downside protection in bear markets and upside potential in bull markets.

Underreaction, Trading Volume, and Momentum Profits in Taiwan Stock Market

This paper uses a very short period to reexamine the momentum effect in Taiwan stock market, focusing on trading volume, size, and book-to-market factors. It is shown that price momentum exists in Taiwan stock market. In addition, trading volume predicts both the magnitude and the persistence of future price momentum. Specifically, the momentum strategy from buying past low-volume winners and selling past high-volume losers have better performance than the momentum strategy from buying past winners and selling past losers. Though Fama and French [27] three factors can partially explain the momentum profits, the momentum effect cannot be subsumed by the difference in risk factors. The profitability of the momentum strategy also cannot be completely explained as a reward for bearing the exposure to industry factors. The more prolonged accumulation of returns and lack of any observable return reversal support delayed reaction as a better explanation for the momentum returns. Besides, momentums in size and industry portfolios are as strong as individual stocks.

What’s Causing Overreaction? An Experimental Investigation of Recency and the Hot‐hand Effect

AbstractA substantial body of empirical literature provides evidence of overreaction in markets. Past losers outperform past winners in stock markets as well as in sports markets. Two hypotheses are consistent with this observation. The recency hypothesis states that traders overweight recent information; they are too optimistic about winners and too pessimistic about losers. According to the hot‐hand hypothesis, traders try to discover trends in the past record of a firm or a team, and thereby overestimate the autocorrelation in the series. An experimental design allows us to distinguish between these hypotheses. The evidence is consistent with the hot‐hand hypothesis.

Pension Plan Funding and Stock Market Efficiency

As a consequence of the recent bear stock market, the aggregate funding level of defined benefit pension plans has tremendously deteriorated. A relevant issue is whether the market value of the firms sponsoring these plans reflects their pension liabilities. In sharp contrast with earlier studies, this paper presents evidence indicating that the market has significantly overpriced firms with severely underfunded pension plans. We show that these companies earn lower stock returns than firms with healthier pension plans, and the underperformance persists for at least five years after the first emergence of the large underfunding. Moreover, the low returns are not explained by risk, return momentum, earnings momentum, or accruals. For this reason, we conclude that we have identified an additional layer of mispricing. We propose an explanation where investors do not anticipate the impact of the pension liability on future earnings and cash flows, and they are surprised when the negative implications of underfunding finally materialize. Consistent with this view, we provide significant evidence of market surprises for severely underfunded firms. Finally, we characterize these firms as past losers which, although value companies, pay low returns.

Extreme volumes and expected stock returns: Evidence from China's stock market

We examine the relation between extreme trading volumes and expected returns for individual stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange over the July 1994–December 2000 interval. Contrasted with the evidence obtained from the US data [J. Finance 56 (2001) 877], our results show that stocks experiencing extremely high (low) volumes are associated with low (high) subsequent returns. Moreover, this extreme volume–return relation significantly co-varies with security characteristics like past stock performance, firm size, and book-to-market values. In particular, stocks with extreme volumes are related to poorer performance if they are past winners, large firms, and glamour stocks than if they are past losers, small firms, and value stocks, respectively. These results are robust to both daily and weekly samples as well as stock exchange sub-samples. Although the liquidity premium hypothesis of Amihud and Mendelson [J. Financ. Econ. 17 (1986) 223] provides a partial explanation for the extreme volume–return relation, our results fit better the behavioral hypothesis of Baker and Stein [J. Financ. Mark. 7 (2004) 271].

Style momentum within the S&amp;P-500 index

Investors may be able to benefit from equity style management. We find that three company characteristics—market value of equity, book-to-market ratio, and dividend yield-capture stylerelated trends in equity returns. We study all firms in the Standard and Poor’s-500 index since 1976. Strategies that buy stocks with characteristics that are currently in favor (past winners) and that sell stocks with characteristics that are out-of-favor (past losers) perform well for periods up to 1 year and possibly longer. Style momentum in equity returns is an empirical phenomenon that is distinct from price and industry momentum. D 2004 Elsevier B.V. All rights reserved.

The Frequency of Mutual Fund Portfolio Disclosure

The costs and benefits of frequent mutual fund portfolio disclosure have been a strong subject for debate. This study investigates both the determinants and potential effects of portfolio disclosure frequency by comparing funds providing voluntary quarterly disclosure to funds providing only mandatory semiannual disclosure. We find that funds with higher turnover, higher expense ratios, and higher likelihood of committing fraud, tend to disclose their holdings less frequently. These characteristics are likely proxies for a fund's informational advantage and/or agency problems. To differentiate between the information effect (i.e. the potential costs of frequent disclosure are higher for funds with informational advantage) and the agency effect (i.e. the potential benefits of frequent disclosure to investors are higher for funds with agency problems), we examine the relation between disclosure frequency and future fund performance conditioned upon fund investment skills. We use past performance as a proxy for fund investment skills. We expect the information effect to outweigh the agency effect for skilled funds and vice versa for unskilled funds. Our findings show a significant asymmetric relation between disclosure frequency and future fund performance for past winners and losers. Consistent with the information effect, past winners who disclose less frequently outperform past winners who disclose more frequently. Consistent with the agency effect, past losers who disclose less frequently underperform past losers who disclose more frequently. These findings are robust to various performance measures. Finally, we analyze the relation between disclosure frequency and fund new money to examine whether investors reward frequent disclosure. Controlling for other fund characteristics, we find higher new money growth for funds providing more frequent disclosure among poorly performing funds.

Profitability of return and volume-based investment strategies in China's stock market

We examine the informational role of the interaction between past returns and past trading volume in the prediction of cross-sectional returns over intermediate horizons in China's stock market. Our results show that low-volume stocks outperform high-volume stocks, volume discounts are more pronounced for past winners than for past losers, low-volume stocks experience return continuations, and high-volume winners exhibit return reversals. Our results are robust to risk adjustments relative to Fama and French's three-factor model, and to stock exchange as well as large stock sub-samples. Our findings are not entirely consistent with the literature, which are likely to result from the market characteristics, in particular, the short-sales prohibition and the dominance of individual investors in the market.

Predictability of short-horizon returns in international equity markets

This paper examines the predictability of equity index returns for 18 developed countries. Based on the variance ratio test, the random walk hypothesis can be rejected at conventional significance levels for 11 countries with daily data and for 15 countries with weekly data. Monthly indices may well be characterized as a random walk for the majority of countries. The excess returns from buying past winners and selling past losers are positive and particularly striking for daily data, where they are not only statistically significant but also economically important in the absence of transaction costs. Imposing a reasonable transaction cost substantially reduces the profitability.

Industry momentum strategies and autocorrelations in stock returns

Abstract In this study, we examine the sources of profits to momentum strategies of buying past winner industry portfolios and selling short past loser industry portfolios. We decompose the profit into (1) own-autocovariances in industry portfolio returns, (2) cross-autocovariances among industry portfolio returns, and (3) cross-sectional dispersion in mean portfolio returns. Our empirical results show that the industry momentum effect is mainly driven by the own-autocorrelation in industry portfolio returns, not by return cross-autocorrelations or by cross-sectional differences in mean returns. Indeed, the industry momentum strategy generates statistically significant profits only when own-autocorrelations are positive and statistically significant. The evidence is consistent with several behavioral models (e.g. Journal of Financial Economics 45 (1998) 307; Journal of Finance 53 (1998) 1839; Journal of Finance 54 (1999) 2143) that suggest positive own-autocorrelations in stock returns and hence the price momentum.