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Decomposing short-term return reversal

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Author Info

  • Zhi Da
  • Qianqiu Liu
  • Ernst Schaumburg

Abstract

The profit to a standard short-term return reversal strategy can be decomposed analytically into four components: 1) across-industry return momentum, 2) within-industry variation in expected returns, 3) under-reaction to within-industry cash flow news, and 4) a residual. Only the residual component, which isolates reaction to recent “nonfundamental” price changes, is significant and positive in the data. A simple short-term return reversal trading strategy designed to capture the residual component generates a highly significant risk-adjusted return three times the size of the standard reversal strategy during our 1982-2009 sampling period. Our decomposition suggests that short-term return reversal is pervasive, much greater than previously documented, and driven by investor sentiment on the short side and liquidity shocks on the long side.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 513.

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Date of creation: 2011
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Handle: RePEc:fip:fednsr:513

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Related research

Keywords: Rate of return ; Liquidity (Economics);

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References

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  1. Nagel, Stefan, 2012. "Evaporating Liquidity," CEPR Discussion Papers 8775, C.E.P.R. Discussion Papers.
  2. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  3. John Y. Campbell & Sanford J. Grossman & Jiang Wang, 1992. "Trading Volume and Serial Correlation in Stock Returns," NBER Working Papers 4193, National Bureau of Economic Research, Inc.
  4. Lubos Pastor & Robert F. Stambaugh, 2001. "Liquidity Risk and Expected Stock Returns," NBER Working Papers 8462, National Bureau of Economic Research, Inc.
  5. Long Chen & Xinlei Zhao, 2009. "Return Decomposition," Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 5213-5249, December.
  6. Robert F. Stambaugh & Jianfeng Yu & Yu Yuan, 2011. "The Short of It: Investor Sentiment and Anomalies," NBER Working Papers 16898, National Bureau of Economic Research, Inc.
  7. Hirshleifer, David & Jiang, Danling, 2007. "A Financing-Based Misvaluation Factor and the Cross Section of Expected Returns," MPRA Paper 20636, University Library of Munich, Germany, revised 10 Feb 2010.
  8. Pástor, Luboš & Sinha, Meenakshi & Swaminathan, Bhaskaran, 2006. "Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital," CEPR Discussion Papers 5462, C.E.P.R. Discussion Papers.
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Cited by:
  1. Blitz, David & Huij, Joop & Lansdorp, Simon & Verbeek, Marno, 2013. "Short-term residual reversal," Journal of Financial Markets, Elsevier, vol. 16(3), pages 477-504.
  2. Robert Ślepaczuk & Grzegorz Zakrzewski & Paweł Sakowski, 2012. "Investment strategies beating the market. What can we squeeze from the market?," Working Papers 2012-04, Faculty of Economic Sciences, University of Warsaw.

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