Long‐Term Return Reversals: Overreaction or Taxes?

Long‐term reversals in U.S. stock returns are better explained as the rational reactions of investors to locked‐in capital gains than an irrational overreaction to news. Predictors of returns based on the overreaction hypothesis have no power, while those that measure locked‐in capital gains do, completely subsuming past returns measures that are traditionally used to predict long‐term returns. In data from Hong Kong, where investment income is not taxed, reversals are nonexistent, and returns are not forecastable either by traditional measures or by measures based on the capital gains lock‐in hypothesis that successfully predict U.S. returns.     

Short-term overreaction to specific events: Evidence from an emerging market

This paper investigates the short-term overreaction to specific events and whether stock prices are predictable in the Egyptian stock exchange (EGX). We find evidence of the short-term overreaction in the EGX. Losers (“bad news” portfolios) significantly outperform winners (“good news” portfolios) and investors can earn abnormal return by selling the winners and buying losers. Terrorist attacks have negative and significant abnormal returns for three days post event followed by price reversals on day four post event. Whereas, the tensions in the Middle East region have a negative and significant abnormal returns on event day followed by price reversals on day one post event. Moreover, the formation of a new government has no effect on the average abnormal returns post event in the EGX. The results also show that small firms tend to have greater price reversals compared to large firms. Overall, our results provide evidence of the leakage of information in the EGX.     

Further Evidence On Investor Overreaction and Stock Market Seasonality

In a previous paper, we found systematic price reversals for stocks that experience extreme long-term gains or losses: Past losers significantly outperform past winners. We interpreted this finding as consistent with the behavioral hypothesis of investor overreaction. In this follow-up paper, additional evidence is reported that supports the overreaction hypothesis and that is inconsistent with two alternative hypotheses based on firm size and differences in risk, as measured by CAPM-betas. The seasonal pattern of returns is also examined. Excess returns in January are related to both short-term and long-term past performance, as well as to the previous year market return.     

High Idiosyncratic Volatility and Low Returns: A Prospect Theory Explanation

The well‐documented negative relationship between idiosyncratic volatility and stock returns is puzzling if investors are risk‐averse. However, under prospect theory, while investors are risk‐averse in the domain of gains, they exhibit risk‐seeking behavior in the domain of losses. Consistent with risk‐seeking investors’ preference for high‐volatility stocks in the loss domain, we find that the negative relationship between idiosyncratic volatility and stock returns is concentrated in stocks with unrealized capital losses, but is nonexistent in stocks with unrealized capital gains. This finding is robust to control for short‐term return reversals and maximum daily return, among other variables.     

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.     

What Drives Stock Price Behavior Following Extreme One-Day Returns

We identify samples of losers and winners by selecting daily stock price returns in excess of 10% (sign ignored) and determine whether these samples over‐ or underreact. We then identify “informed” events, which correspond to announcements in the Wall Street Journal(WSJ), and “uninformed” events, which are not explained in the WSJ. For winners, there is overreaction in response to uninformed events but no overreaction on average in response to informed events. This finding suggests the degree of overreaction to new information depends on whether the cause of the extreme stock price change is publicly released.     

DO U.S. STOCK MARKET INDEXES OVER‐ OR UNDERREACT?

Our objective is to investigate the short‐term over‐ or underreaction of six U.S. stock market indexes. We find evidence of a one‐day underreaction for winners (days on which an index experiences abnormally high returns) and losers (days on which an index experiences abnormally poor performance). We also find strong evidence of a sixty‐day underreaction for winners. For losers, abnormal returns turn from negative to positive as the period is extended, resulting in significant reversals over the sixty‐day period. Results are generally consistent for each of the six indexes. Overall, these results provide strong support for the uncertain information hypothesis. JEL classification: G14     

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.     

The 52-Week High and Momentum Investing

When coupled with a stock's current price, a readily available piece of information—the 52‐week high price–explains a large portion of the profits from momentum investing. Nearness to the 52‐week high dominates and improves upon the forecasting power of past returns (both individual and industry returns) for future returns. Future returns forecast using the 52‐week high do not reverse in the long run. These results indicate that short‐term momentum and long‐term reversals are largely separate phenomena, which presents a challenge to current theory that models these aspects of security returns as integrated components of the market's response to news.     

Capital gains tax,supply‐driven trading and ownership structure: direct evidence of the lock‐in effect

This study investigates the effect of differential capital gains tax rates on investor trading and share prices in a unique market setting that facilitates the resolution of conflicting prior evidence of holding period tax incentives. In particular, we examine whether the concessionary tax treatment of long‐term capital gains increases the supply of shares that qualify for long‐term status, thereby causing downward price pressure. We find evidence of abnormal seller‐initiated trading following the 12‐month anniversary of listing for IPO firms that appreciate in price (‘winners’) and report no such evidence for firms that decline in price (‘losers’). Consistent with the tax concessions being greater for individual than institutional investors, we report that abnormal seller‐initiated trading is mitigated by higher levels of ownership by institutional investors. We also report limited evidence, for winners, of declining share prices upon qualifying for long‐term tax status.     

Institutional investors,intangible information,and the book-to-market effect

This paper establishes a robust link between the trading behavior of institutions and the book-to-market effect. Building on work by Daniel and Titman (2006), who argue that the book-to-market effect is driven by the reversal of intangible returns, I find that institutions tend to buy (sell) shares in response to positive (negative) intangible information and that the reversal of the intangible return is most pronounced among stocks for which a large proportion of active institutions trade in the direction of intangible information. Furthermore, the book-to-market effect is large and significant in stocks with intense past institutional trading but nonexistent in stocks with moderate institutional trading. This influence of institutional trading on the book-to-market effect is distinct from that of firm size. These results are consistent with the view that the tendency of institutions to trade in the direction of intangible information exacerbates price overreaction, thereby contributing to the value premium.     

THE EFFECT OF SIZE,BOOK-TO-MARKET EQUITY,PRIOR RETURNS,AND BETA ON STOCK RETURNS: JANUARY VERSUS THE REMAINDER OF THE YEAR

Size and book-to-market equity are shown to transcend beta in explaining stock returns. One possible explanation of the book-to-market equity effect is overreaction. We investigate the effect of size, book-to-market equity, prior returns, and beta on stock returns. We find significant reversals in January consistent with overreaction. We find a strong positive relation between returns and prior returns for February through December. Both patterns are distinct from either a size or book-to-market equity effect. Book-to-market equity is significantly related to returns, with some evidence of a stronger effect in January.     

Do Low‐Priced Stocks Drive Long‐Term Contrarian Performance on the London Stock Exchange?

We investigate whether low‐priced stocks drive long‐term contrarian performance on the U.K. market. We find that contrarian performance at low, middle, and high price levels is positive. On the Fama‐French risk adjusted basis, we find both low‐priced and middle‐priced losers have significantly positive returns. When we adjust returns by market and liquidity risk, only middle‐priced losers maintain their positive returns. Our results reveal that low‐priced stocks are not fully responsible for contrarian performance. Our empirical evidence is generally consistent with the overreaction hypothesis and behavioral models of value investing.     

Does the Stock Market Overreact to Corporate Earnings Information?

This paper tests whether the stock market overreacts to extreme earnings, by examining firms' stock returns over the 36 months subsequent to extreme earnings years. While the poorest earners do outperform the best earners, the poorest earners are also significantly smaller than the best earners. When poor earners are matched with good earners of equal size, there is little evidence of differential performance. This suggests that size, and not investor overreaction to earnings, is responsible for the “overreaction” phenomenon, the tendency for prior period losers to outperform prior period winners in the subsequent period.     

Changes in Non‐current Assets and in Property,Plant and Equipment and Future Stock Returns: The UK Evidence

We examine the effect of changes in non‐current operating assets (NCOA) and of changes in property, plant and equipment (PPE) on future abnormal stock returns using a sample of 21,549 UK non‐financial firm observations over the 1990–2012 event period. The results from a matching portfolio procedure and 4‐factor regressions indicate that abnormal returns from investing in a portfolio of low‐minus‐high quintile NCOA and PPE change firms are between 5.5% and 6.1%. This negative association is confirmed by cross‐sectional regressions. The economic significance of mispricing seems weaker than in the US and weaker than the mispricing of working capital accruals adjusted for depreciation in the UK. Changes in PPE drive the predictability of share returns with respect to changes in NCOA. There is no significant evidence that return predictability is stronger in less liquid firms. We find two strands of evidence that lend some support to behavioural explanations of predictability through overreaction to investment. On one hand, fundamental information about investment explains one‐third of the predictability of returns while, on the other, predictability is generally not significantly stronger in firms with high operating leverage as a proxy for risk.     

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.     

Distinguishing Between Rationales for Short‐Horizon Predictability of Stock Returns

In this paper, we shed light on short‐horizon return reversals. We show theoretically that a risk‐based rationale for reversals implies a relation between returns and past order flow, whereas a reversion in beliefs of biased agents does not do so. The empirical results indicate that returns are more strongly related to own‐return lags than to lagged order imbalances. Thus, the evidence suggests that monthly reversals are not completely captured by inventory effects and may be driven, in part, by belief reversion. We do find that returns are cross‐sectionally related to lagged imbalance innovations at horizons longer than a month.     

Long-Term Market Overreaction or Biases in Computed Returns?

We show that the returns to the typical long-term contrarian strategy implemented in previous studies are upwardly biased because they are calculated by cumulating single-period (monthly) returns over long intervals. The cumulation process not only cumulates “true” returns but also the upward bias in single-period returns induced by measurement errors. We also show that the remaining “true” returns to loser or winner firms have no relation to overreaction. This study has important implications for event studies that use cumulative returns to assess the impact of information events.     

Capital gains taxation and shareholder wealth in takeovers

Before December 1999, the capital gains of shareholders who sold their shares into Australian takeovers have been taxable irrespective of payment method. Subsequently, shareholders can elect to rollover capital gains in equity takeovers. We examine the effect of this change on the association between target shareholder capital gains and bidder and target firm shareholder wealth. The results indicate that prior to the regulatory change, cash consideration results in higher target shareholder returns for non‐taxation reasons. After the introduction of capital gains tax rollover relief, we find that target and acquiring firm shareholders earn lower returns when cash consideration is offered to shareholders with greater capital gains.