Winner-Loser Reversals in National Stock Market Indices: Can They be Explained?

This article examines possible explanations for “winner-loser reversals” in the national stock market indices of 16 countries. There is no evidence that loser countries are riskier than winner countries either in terms of standard deviations, covariance with the world market or other risk factors, or performance in adverse economic states of the world. While there is evidence that small markets are subject to larger reversals than large markets, perhaps due to some form of market imperfection, the reversals are not only a small-market phenomenon. The apparent anomaly of winner-loser reversals in national market indices therefore remains unresolved.     

Are idiosyncratic volatility and MAX priced in the Canadian market?

The negative relationship between realized idiosyncratic volatility (RIvol) and future returns uncovered by Ang et al. (2006) for the U.S. market has been attributed to return reversals. For the Canadian market where return reversals are considerably less important, we find that RIvol is positively related to future returns, even after controlling for risk loadings, illiquidity and reversals. Unlike the findings of Bali et al. (2001) for the U.S. market, we find that the relationship between extreme positive returns (MAX) and future returns for the Canadian market is positive and that idiosyncratic volatility continues to be consistently positively related to future returns after controlling for MAX. We find evidence that suggests that reversals for stocks with extreme daily returns are confined to (typically small) stocks with low institutional holdings.     

The Predictability of Short-Horizon Stock Returns

This examines the predictability of short-horizon stock returnsin the UK. We show that the subsequent return reversal of previousextreme performers is unlikely to be caused by either lead-lageffects or inventory imbalances, the most likely explanationbeing market overreaction. A market or trading based explanationis reinforced by the finding that these return reversals areasymmetric, being less significant after bad news. Further,we find that the lower transacting stocks exhibit the strongerreturn reversals, in direct contrast to both the existing USevidence and the implication that liquidity effects can explainthe return reversals. JEL Classification: G10, G11, G12     

Intraday price reversals in the US stock index futures market: A 15-year study

This paper gives a long-term assessment of intraday price reversals in the US stock index futures market following large price changes at the market open. We find highly significant intraday price reversals over a 15-year period (November 1987–September 2002) as well as significant intraday reversals in our yearly and day-of-the-week investigations. Moreover, the strength of the intraday overreaction phenomenon seems more pronounced following large positive price changes at the market open. That being said, the question of whether a trader can consistently profit from this information remains open as the significance of intraday price reversals is sharply reduced when gross trading results are adjusted by a bid–ask proxy for transactions costs.     

News-driven return reversals: Liquidity provision ahead of earnings announcements

This study documents a six-fold increase in short-term return reversals during earnings announcements relative to non-announcement periods. Following prior research, we use reversals as a proxy for expected returns market makers demand for providing liquidity. Our findings highlight significant time-series variation in the magnitude of short-term return reversals and suggest that market makers demand higher expected returns prior to earnings announcements because of increased inventory risks that stem from holding net positions through the release of anticipated earnings news. Collectively, our findings suggest that uncertainty regarding anticipated information events elicits predictable increases in the compensation demanded for providing liquidity and that these increases significantly affect the dynamics and information content of market prices.     

Price reversal,transaction costs,and arbitrage profits in the real estate securities market

This paper studies the return reversals of exchange traded real estate securities using an arbitrage portfolio approach. Using the approach, we find that there exist significant return reversals in such securities. These return reversals could be exploited by arbitrage traders if trading costs can be ignored. However, the arbitrage profits disappear after deducting trading costs and taking into account the implicit cost of bid-ask spread. Thus, the real estate securities market is efficient at weekly intervals in the sense that one could not exploit the price reversals via some simple trading rules.     

Cross-sectional seasonalities and seasonal reversals: Evidence from China

We are the first to comprehensively investigate cross-sectional seasonalities and seasonal reversals in the Chinese A-share market. Empirically, utilizing monthly data from January 1995 to December 2019, we provide new supporting evidence that there are seasonalities and seasonal reversals in the cross-section. Interestingly, the occurrence of seasonal reversals takes a longer time than that of the U.S. market. Next, we explore explanations for cross-sectional seasonalities. The tests based upon macroeconomic risk, mood beta, and limits of arbitrage suggest that seasonalities are likely driven by temporary mispricing. Finally, we construct seasonality and seasonal reversal factors to study the investment value of seasonalities. We find that these factors can significantly increase the monthly Sharpe ratio by up to 0.34 and capture incremental information in predicting future returns relative to other well-known factors.     

Liquidity and Autocorrelations in Individual Stock Returns

This paper documents a strong relationship between short‐run reversals and stock illiquidity, even after controlling for trading volume. The largest reversals and the potential contrarian trading strategy profits occur in high turnover, low liquidity stocks, as the price pressures caused by non‐informational demands for immediacy are accommodated. However, the contrarian trading strategy profits are smaller than the likely transactions costs. This lack of profitability and the fact that the overall findings are consistent with rational equilibrium paradigms suggest that the violation of the efficient market hypothesis due to short‐term reversals is not so egregious after all.     

LONG-TERM STOCK PRICE REVERSALS IN THE UK: EVIDENCE FROM REGRESSION TESTS

This paper seeks to advance our knowledge about the UK evidence on long-term stock price reversals. Many of the major studies of long-term reversals have been done using US data, prompting fears about data snooping biases. There have been comparatively few UK studies and they have all employed contrarian portfolio techniques to identify evidence of reversals. None of these UK studies has used cross-section regression tests, which have been employed in some of the US investigations, and this paper aims to fill this gap. We find evidence of stock price reversals, even after controlling for time-varying risk and restricting the study to larger, UK-listed companies—that is, companies that are frequently traded, more heavily regulated and extensively analysed by market commentators, analysts and institutional investors.     

Overreaction in the Brazilian stock market

The overreaction hypothesis on a new set of data for the Brazilian stock market over the period 1970–1989 is investigated. Both market adjusted returns and the standard Sharpe-Lintner CAPM adjusted returns are used. Price reversals in 2-year returns are detected and the results contrast with the U.S. evidence in that the magnitude of the effect is more pronounced than in the U.S. The results also suggest that differences in risk, as measured by CAPM-betas using the method suggested by Chan (Chan K.C., 1988, On the contrarian investment strategy, Journal of Business 61, 147–163), cannot account for the overreaction effect. I also examine the issue of asymmetry versus symmetry in the overreaction effect. Using the criterion proposed by Dissanaike (Dissanaike G., 1992, Are stock price reversals really symmetric? University of Cambridge Department of Applied Economics Discussion Paper, AF series, No. 4) I find evidence that the price reversals are asymmetric.     

Do the prices of stock index futures in Asia overreact to U.S. market returns?

We extend the overreaction study to interaction of international markets and find that intraday price reversals exist in Asian index futures markets following extreme movement in U.S. market. Profitable opportunities exist after considering transaction cost. We show that the reversal cannot be explained by rational arguments such as risk, liquidity and bid-ask spread. We further observe that a magnitude effect exists. Overreaction is more prominent in the latter period than in the initial period. After calm-down periods, overreaction is greatly reduced. These observations support the explanation that the source of price reversals lies in behavioral biases.     

Bank Structure, Relationship Lending and Small Firm Access to Finance: A Cross-Country Investigation

This paper examines whether the stock price of the rating agency Moody’s reacts negatively to rating actions that could indicate low rating quality. The reaction to rating reversals, which Moody’s describes as particularly damaging to investors, is economically significant. It suggests that market discipline has the potential to influence agency behavior. On the other hand, defaults of highly rated issuers do not consistently impact Moody’s stock price. The focus on reversals and the neglect of default events are consistent with either collusion or with misconceptions of how rating quality should be evaluated. Both interpretations question whether market discipline can be sufficient to ensure a socially optimal rating policy within the current environment.     

WINNERS AND LOSERS ON NYSE: A RE-EXAMINATION USING DAILY CLOSING BID-ASK SPREADS

We study a sample of NYSE stocks that experienced a large one-day price change during 1992 and were reported as daily largest percentage gainers and largest percentage losers in the Wall Street Journal. The sample indicates significant reversals during the immediate post-announcement period. We test for market efficiency by using bid-ask spreads obtained from the transactions data for the days immediately after the announcement. The overall results indicate that the returns during the reversal period are less than the average bid-ask spread during the same time. We also find that major losers, firms with ?20 percent to ?50 percent event-date abnormal returns, experience price reversals generating returns that are significantly greater than the average bid-ask spread during that period. We interpret this result as consistent with the overreaction hypothesis. A test of a trading rule to exploit this overreaction is not profitable, providing support for weak-form market efficiency.     

A behavioral explanation of the value anomaly based on time-varying return reversals

We investigate the dynamics of the value anomaly in order to identify the driving forces of the anomaly. We show that the large positive value-minus-growth portfolio returns are explained by an over-reaction (under-reaction) to the positive (negative) market movements in short, specific time periods, during which the average returns of value-minus-growth portfolios are more than 2% a month. We propose an explanation based on behavioral biases: the dynamics of the value anomaly reflect the increased speed of return reversals subsequent to overreaction. Two conditions that increase the return reversals are proposed: when investors respond to public signals asymmetrically or when public signals become noisy. Our empirical results reveal that the value anomaly is explained by either one of these two channels.     

Long-term reversals in the corporate bond market

Long-term reversals in corporate bonds are economically and statistically significant in a comprehensive sample spanning the period 1977 to 2017. Such reversals are stronger for bonds with high credit risk and more binding regulatory, capital, and funding liquidity constraints. Bond long-term reversal is not a manifestation of the equity counterpart and is mainly driven by long-term losers. A long-term reversal factor carries a sizable premium and is not explained by long-established equity and bond market factors. Thus, past returns capture investors’ ex-ante risk assessment and the degree of institutional constraints they face, so losing bonds command higher expected returns.     

Predicting the next step of a random walk: experimental evidence of regime-shifting beliefs

Barberis et al. (J. Financial Econ. 49 (1998) 307), construct a model in which investors use the prevalence of past trend reversals as an indicator of the likelihood of future reversals. While such “regime-shifting” beliefs are consistent with a variety of psychological theories, other contrary predictions are consistent with the same theories. We report two experiments with MBA-student participants that strongly support the existence of regime-shifting beliefs. We conclude that regime-shifting models can provide a useful framework for understanding market anomalies, including underreactions to earnings changes and overreactions to long-term earnings trends.     

What drives acquisitions?: Market valuations and bidder performance

Given the recent theoretical development that documents stock market misvaluations’ driven acquisition, this paper examines the relation between market valuations and bidder performance. We focus on hot stock markets and find that bidder reactions to mergers, in both the short- and long-run period, are consistent with the predictions of investors’ sentiment (optimism) after controlling for target type and method of payment. Managers that undertake mergers during bullish periods are rewarded by the generalized upward trend of the market in the short-run. However, this is followed by long-term reversals as the market learns only gradually that many of the mergers undertaken during hot periods were not carefully evaluated and were made under the pressure of ‘urge to merge’ to take advantage of the overall market status of a particular period.     

The interaction between opening call auctions and ongoing trade: Evidence from the NYSE

We investigate the impact that the opening batch has on trading for the remainder of the day and what impact the prior day's trading has on the subsequent day's open. Traders have an interest in these trading impacts as their trades may cluster around opening and closing time periods. We find that the larger the volume in the opening batches, the greater the volume across the day. We also find the prior day's volume being positively related to the subsequent day's opening volume. Combined, these results suggest a continuing pattern of trade volume rolling from one day to the next. Additionally, we find that the spread in the continuous market can be partially attributed to the price change in the opening batch. We also find evidence of opening trade price reversals. Combined with the absence of price reversals following the opening trade, we conclude that the opening process may be more efficient at handling information than the continuous market.     

How do firms react to the prohibition of long-lived asset impairment reversals? Evidence from China

New Chinese Accounting Standards (CAS) released on February 15, 2006, prohibit the reversal of long-lived asset impairments, effective for reporting periods beginning January 1, 2007 and later. This development in the Chinese market provides a unique experimental setting to directly investigate how firms react to the ban on previously-allowed long-lived asset impairment reversals, especially firms that use impairment charges as “cookie jar reserves.” By contrasting write-off recognition and reversal across the pre- and post- new CAS announcement regimes, we show that firms listed on Chinese stock exchanges recognized less impairment charges during the “transition” period—after announcement of the new standard and before the effective date—than in pre-announcement periods. Meanwhile, firms with substantial previous write-downs reversed more impairment charges to achieve their earnings targets in the transition period. The new CAS also constraints “big bath” reporting by loss firms. As US GAAP prohibits these reversals and IFRS allows them, our empirical evidence depicts firms’ possible reactions in other regimes contemplating doing away with such reversals.