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Evidence to the contrary: extreme weekly returns are underreactions

The finding of reversals in weekly returns has been attributed to a combination of microstructure issues and overreaction to information. I provide new evidence eliminating overreaction as a source of reversal. I show that well-known weekly contrarian profits are followed by a long run of momentum profits. In fact, these profits are strong enough to produce a significant momentum effect over the full year following portfolio formation. Thus, the market does not appear to view extreme weekly returns as excessive, as implied by an overreaction story. To the contrary, this return continuation is consistent with underreaction to the news driving extreme weekly returns. This is supported by cross-sectional tests in which I find this week's news is positively related to next week's returns. The evidence presented here is consistent with growing evidence that underreaction to firm-specific information is a pervasive feature of price formation. Therefore, if any short-run contrarian profits can be realized, they are better viewed as compensation for providing liquidity than as a reward for arbitrage.

Identiferoai:union.ndltd.org:TEXASAandM/oai:repository.tamu.edu:1969/1065
Date15 November 2004
CreatorsKelley, Eric Kyle
ContributorsFields, L. Paige, Gutierrez, Roberto C., Jr., Pirinsky, Christo, Blackwell, David W., Rees, Lynn
PublisherTexas A&M University
Source SetsTexas A and M University
Languageen_US
Detected LanguageEnglish
TypeElectronic Dissertation, text
Format375037 bytes, 125767 bytes, electronic, application/pdf, text/plain, born digital

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