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Gradual information diffusion and contrarian strategies

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  • YalçIn, Atakan
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    Abstract

    Various rational and behavioral models have been proposed to explain contrarian portfolio returns. In this article, I test the gradual information diffusion model of Hong and Stein [Hong, H., & Stein J. C. (1999). A unified theory of underreaction, momentum trading, and overreaction in asset markets. Journal of Finance, 54, 2143-2184]. Specifically, I study contrarian strategies based on past long-term returns and fundamental value-to-price ratios. Using ex post returns as a proxy for expected returns and size-controlled analyst coverage as a proxy for the rate of information diffusion, I show that contrarian portfolio returns decline monotonically with increasing rates of information diffusion. These results are consistent with the predictions of the Hong and Stein model. In addition, I show that analyst coverage is more important among glamour than value stocks, supporting the view that investors are more prone to decision biases when it comes to pricing hard-to-value glamour stocks for which information is relatively more ambiguous.

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    Bibliographic Info

    Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

    Volume (Year): 48 (2008)
    Issue (Month): 3 (August)
    Pages: 579-604

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    Handle: RePEc:eee:quaeco:v:48:y:2008:i:3:p:579-604

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    Web page: http://www.elsevier.com/locate/inca/620167

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