On the usefulness of the contrarian strategy across national stock markets: A grid bootstrap analysis

This paper statistically evaluates the usefulness of the contrarian investment strategy across the national stock markets of 18 developed countries. The contrarian strategy implicitly assumes that asset prices tend toward a fundamental value path over time. Conventional bootstrap analyses and panel unit root tests are often consistent with such a hypothesis. However, these results might be contaminated by small-sample bias and/or by not controlling cross-section dependence. Correcting for small-sample bias nonparametrically, I find extremely slow mean reversion rates, which provide strong evidence against the usefulness of the contrarian strategy.     

Overreaction, delayed reaction, and contrarian profits

This article examines the contribution of stock price overreactionand delayed reaction to the profitability of contrarian strategies.The evidence indicates that stock prices overreact to firm-specificinformation, but react with a delay to common factors. Delayedreactions to common factors give rise to a size-related lead-lageffect in stock returns. In sharp contrast with the conclusionsin the extant literature, however, this article finds that mostof the contrarian profit is due to stock price overreactionand a very small fraction of the profit can be attributed tothe lead-lag effect.     

Momentum trading,mean reversal and overreaction in Chinese stock market

The vast majority of the literature reports momentum profitability to be overwhelming in the US market and widespread in other countries. However, this paper finds that the pure momentum strategy in general does not yield excess profitability in the Chinese stock markets. We find instead strong mean reversion with an average half-life slightly shorter than 1 year. A pure contrarian investment strategy produces positive excess returns and in general outperforms the pure momentum strategy. Furthermore, momentum may interact with mean reversion. A strategy based on the rolling-regression parameter estimates of the model combining mean reversion and momentum generates both statistically and economically significant excess returns. The combined strategy outperforms both pure momentum and pure contrarian strategies. We conduct a number of robustness tests and confirm the basic findings. Collectively, our results support the overreaction hypothesis.     

Does an intertemporal tradeoff between risk and return explain mean reversion in stock prices?

When volatility feedback is taken into account, there is strong evidence of a positive tradeoff between stock market volatility and expected returns on a market portfolio. In this paper, we ask whether this intertemporal tradeoff between risk and return is responsible for the reported evidence of mean reversion in stock prices. There are two relevant findings. First, price movements not related to the effects of Markov-switching market volatility are largely unpredictable over long horizons. Second, time-varying parameter estimates of the long-horizon predictability of stock returns reject any systematic mean reversion in favour of behaviour implicit in the historical timing of the tradeoff between risk and return.     

Mean reversion versus random walk in G7 stock prices evidence from multiple trend break unit root tests

This paper provides evidence on the random walk hypothesis in G7 stock price indices using unit root tests which allow for one and two structural breaks in the trend. Of the seven countries we find, at best, evidence of mean reversion in the stock price index of Japan. Thus, overall, our results support the random walk hypothesis. We also consider the implications of the identified structural breaks for movement in stock prices over time. Our main conclusion from this exercise is that the second break in stock prices has had a detrimental effect on movements in stock prices in the G7 countries.     

Property Company Stock Price and Net Asset Value: A Mean Reversion Perspective

This study investigates the relationship between property company stock prices (P) and their net asset values (NAV) from a mean reversion perspective. In contrast to U.K. evidence, we find that there is absence of a long-term stable relationship between the two series. However, the variance ratio tests and multi-period regressions suggest that both P and NAV series have exhibited transitory components. In addition, there is some evidence of mean reversion behavior of Singapore property stock prices toward the property companies' NAVs over the past 15 years from 1985 to 1999, both at individual company level and in the sector as a whole. The results also reveal that NAV, as a traditional proxy to fundamental value, is significant in capturing the dynamics of the changes in property stock prices. Hence NAV is relevant in property company valuation. However the extent of mean reversion between the property stock prices and NAVs is slow and deviations between the two markets' valuation could therefore be prolonged.     

Mean reversion in Southeast Asian stock markets

This paper assesses the predictable component of South East Asian stock markets using a bootstrap resampling method to estimate the small sample distributions of variance ratio statistics. We find evidence of mean reversion in long horizon dollar adjusted excess returns. The robustness of the results is assessed by adjusting stock returns for potential time-varying expected returns and partial integration of these emerging markets into world capital markets. In all but one case, mean reversion is shown to be due to either time-variation of risk exposure and prices of risk or partial integration of the local market into world stock markets. These results clearly illustrate the dangers of testing market efficiency without carefully adjusting stock returns for time variation in expected returns and the partial integration of local markets into world markets.     

A Bayesian view of temporary components in asset prices

This paper studies models in which the a stock price contains a random walk and a stationary component, as in Fama and French [Fama, Eugene F., and Kenneth R. French, 1988, Permanent and Temporary Components of Stock Returns, Journal of Political Economy 96, 246–273.] and Poterba and Summers [Poterba, James, and Lawrence Summers, 1988, Mean Reversion in Stock Prices: Evidence and Implications, Journal of Financial Economics 22, 27–59.]. We extend this model to allow for two latent factors which generate short term and long term autocorrelations, respectively. To facilitate econometric identification, we assume that these factors are common across multiple asset returns, and we estimate the factor loadings. In an application to size and book/market sorted portfolios, we find the short term factor economically and statistically insignificant. Estimates of parameters relating to the long range component suggest that portfolios of small firm stock display about three times the amount of mean reversion than for large firm stocks. Overall, the evidence suggests that mean reversion is largely a small firm phenomenon. The evidence is consistent with dynamic equilibrium models in which asset prices co-integrate with aggregate consumption or dividends.     

Are investors consistent in their trading strategies? An examination of individual investor-level data

While it has been demonstrated that momentum or contrarian trading strategies can be profitable in a range of institutional settings, less evidence is available concerning the actual trading strategies investors adopt. Standard definitions of momentum or contrarian trading strategies imply that a given investor applies the same strategy to both their buy and sell trades, which need not be the case. Using investor-level, transaction-based data from China, where tax effects are neutral, we examine investors' buy-sell decisions separately to investigate how past returns impact differentially on the trading strategies investors adopt when buying and selling stock. After controlling for a wide range of stock characteristics, extreme price changes and portfolio value, a clear asymmetry in trading is observed; with investors displaying momentum behavior when buying stocks, but contrarian behavior when selling stocks. This asymmetry in behavior is not driven purely by reactions to stock characteristics or extreme stocks. We discuss behavioral and cultural explanations for our findings.     

Net Asset Value Discounts for Asian-Pacific Real Estate Companies: Long-Run Relationships and Short-Term Dynamics

This study investigates the time series behavior of real estate company net asset value discount/premium (NAVDISC) in eight Asian-Pacific securitized real estate markets from 1995 to 2003. We postulate that if there is a stable NAVDISC for real estate companies in the long-run, then there should be a long-run cointegrating relation between their stock prices (Ps) and net asset values (NAVs). Employing panel data cointegration econometrics that comprises three approaches; panel unit root test, heterogeneous panel cointegration test and dynamic panel error-correction modeling (ECM), we find that long run NAVDISCs persist in individual Asian-Pacific securitized real estate markets and the regional market. All the NAVDISCs exhibit mean reversion and that the respective disequilibrium errors fluctuate around the mean values. Moreover, NAV is an important factor that statistically explains the price variations in real estate stock prices regardless of their speed of mean-reversion in the NAV discount /premium.     

Mean reversion in stock market prices: New evidence based on bull and bear markets

In this paper we test whether mean reversion in stock market prices presents a different behavior in bull and bear markets. We date the US bull and bear periods using Bry and Boschan (1971) algorithm. We examine the order of integration in the S&P 500 stock market index covering a daily period from August 1929 to December 2006 in bull and bear phases. Our results indicate the existence of different episodes of mean reversion, which mainly correspond to bull market periods.     

Testing for mean reversion in heteroskedastic data II: Autoregression tests based on Gibbs-sampling-augmented randomization

A decade ago Fama and French [Fama, E.G., French, K.R., 1988. Permanent and temporary components of stock prices. J. Political Econ. 96 (2) 246–273] estimated that 40% of variation in stock returns was predictable over horizons of 3–5 yr, which they attributed to a mean reverting stationary component in prices. While it has been clear that the Depression and war years exert a strong influence on these estimates, it has not been clear whether the large returns of that period contribute to the information in the data or rather are a source of noise to be discounted in estimation. This paper uses the Gibbs-sampling-augmented randomization methodology to address the problem of heteroskedasticity in estimation of multi-period return autoregressions. Extending the sample period to 1995, we find little evidence of mean reversion. Examining subsamples, only 1926–1946 provides any evidence of mean reversion, while the post war period is characterized by mean aversion. A test of structural change suggests that this difference between pre and post war periods is significant.     

Mean Reversion in the United Kingdom Stock Market and its Implications for a Profitable Trading Strategy

Following Fama and French (1988), we examine the mean reverting behavior of the United Kingdom stock market total returns over the period 1919 through 1990. Evidence of statistically significant mean reversion is only found during the pre-war subperiod. A contrarian investment strategy, however, does not enhance performance over a naive buy and hold investment strategy. Further, an application of Richardson and Stock's (1989) alternative asymptotic distribution theory suggests that the mean reversion detected during the pre-war period may reflect the poor finite sample approximation of traditional fixed overlap asymptotic distribution theory.     

Testing for mean reversion in heteroskedastic data II: Autoregression tests based on Gibbs-sampling-augmented randomization

A decade ago Fama and French [Fama, E.G., French, K.R., 1988. Permanent and temporary components of stock prices. J. Political Econ. 96 (2) 246–273] estimated that 40% of variation in stock returns was predictable over horizons of 3–5 yr, which they attributed to a mean reverting stationary component in prices. While it has been clear that the Depression and war years exert a strong influence on these estimates, it has not been clear whether the large returns of that period contribute to the information in the data or rather are a source of noise to be discounted in estimation. This paper uses the Gibbs-sampling-augmented randomization methodology to address the problem of heteroskedasticity in estimation of multi-period return autoregressions. Extending the sample period to 1995, we find little evidence of mean reversion. Examining subsamples, only 1926–1946 provides any evidence of mean reversion, while the post war period is characterized by mean aversion. A test of structural change suggests that this difference between pre and post war periods is significant.     

Do leveraged warrants prompt individuals to speculate on stock price reversals?

Using proprietary data on bank-issued knock-out warrants written on a stock index, we find that individual investors’ aggregate warrant portfolio speculates against the short-term trend of the index. We argue that contrarian trading is driven by the interaction of product design and investors’ preference for large leveraged positions. Investors tend to open larger positions whenever warrants offer higher leverage. As a result, investors open an aggregate long position when calls offer higher leverage than puts. Since knock-out leverages move systematically with the underlying, aggregate warrant positions become contrarian even if investors do not intend to speculate on reversals.     

On the information role of stock recommendation revisions

We examine the information transmission role of stock recommendation revisions by sell-side security analysts. Revisions are associated with economically insignificant mean price reactions and often piggyback on recent news, events, long-term momentum, and short-run contrarian return predictors, typically downgrading after bad news and upgrading after good news. However, the revisions are usually information-free for investors. The findings go against the long-standing view that recommendations are an important means by which analysts assimilate information into stock prices. They disagree with the view of policymakers that analysts’ stock picks materially impact stock prices.     

Selectivity,Quality Adjustment and Mean Reversion in the Measurement of House Values*

This paper develops a model of price formation in the housing market which accounts for the non-random selection of those dwellings sold on the market from the stock of existing houses. The model we develop also accounts for changes in the quality of dwellings themselves and tests for mean reversion in individual house prices. The model is applied to a unique body of data representing all dwellings sold in Sweden's largest metropolitan area during the period 1982–1999. The analysis compares house price indices that account for selectivity, quality change and mean reversion with the conventional repeat sales models used to describe the course of metropolitan housing prices. We find that the repeat sales method yields systematically large biased estimates of the value of the housing stock. Our comparison suggests that the more general approach to the estimation of housing prices or housing wealth yields substantially improved estimates of the course of housing prices and housing wealth.     

Asymmetric reverting behavior of short-horizon stock returns: An evidence of stock market overreaction

This paper investigates the uneven mean reverting pattern of monthly return indexes of the NYSE, AMEX and NASDAQ, using asymmetric non-linear smooth-transition (ANST) GARCH models. It also evaluates the extent to which time-varying volatility in the index returns support the stock market overreaction hypothesis. The models illuminate patterns of asymmetric mean reversion and risk decimation. Between 1926:01 and l997:12, not only did negative returns reverse to positive returns quicker than positive returns reverted to negative ones, but negative returns, in fact, reduced risk premiums from predictable high volatility. The findings support the market overreaction hypotheses. The asymmetry is due to the mispricing behavior on the part of investors who overreact to certain market news. The findings also corroborate arguments for the “contrarian” portfolio strategy.     

RANDOM WALK TESTS FOR LATIN AMERICAN EQUITY INDEXES AND INDIVIDUAL FIRMS

In this study we re-examine the presence of random walk in stock prices in Brazil and Mexico. We employ variance ratio tests on weekly stock returns for indexes as well as individual firms. The results reveal mean aversion in Mexico at both the index level and the firm level. In contrast, the Brazil indexes show a greater tendency toward random walk; however, the results for the individual firms suggest mean reversion. The results cannot be attributed to a firm size effect. Evidence is presented in favor of a greater degree of nonsynchronous trading for Brazilian securities than for Mexican securities.     

ARE LONG-HORIZON STOCK RETURNS PREDICTABLE? A BOOTSTRAP ANALYSIS

This paper examines empirical evidence of predictability of long-horizon real and excess stock returns in the UK using univariate as well as multivariate Variance Ratio tests. In order to estimate the sampling distribution of the test statistics, artificial histories ofstock returns are generated from their empirical distribution using the bootstrap method. This allows the construction of significance levels of the test statistic which are free from distributional assumptions. The empirical results indicate that there is no evidence of mean reversion in stock prices even if a wider information set to forecast stock returns is used and that the significance of historical Variance Ratio statistics has been overstated by previous studies.