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Maxing out short-term reversals in weekly stock returns

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  • Chen, Chen
  • Cohen, Andrew
  • Liang, Qiqi
  • Sun, Licheng

Abstract

Subrahmanyam (1991) presents a model in which increased variance in liquidity trades reduces price efficiency when market makers are risk-averse. Motivated by this theoretical insight, we hypothesize that pent-up demand from lottery-seeking investors amplifies their overreactions to news, leading to larger short-term return reversals. Consistent with this hypothesis, we identify a significant pattern in weekly U.S. stock returns for lottery-like stocks, defined by high recent maximum daily returns (MAX). Specifically, high-MAX stocks that were past 1-week losers (or winners) exhibit notably positive (or negative) returns in the following week. Applying a short-term reversal strategy to high-MAX stocks generates an average weekly return of 1.66%, significantly outperforming the 0.65% return from the same strategy applied to low-MAX stocks. This result remains robust even after controlling for market microstructure biases and survives a series of robustness tests. Interestingly, the MAX-enhanced reversal strategy proves effective only when retail order imbalance is in the highest quintile. This result holds across both value-weighted and equal-weighted portfolios, underscoring the pivotal role of retail investors. Taken together, our findings highlight a new channel through which retail investors’ preference for lottery-like payoffs amplifies their overreactions, enhancing the profitability of short-term reversal strategies.

Suggested Citation

  • Chen, Chen & Cohen, Andrew & Liang, Qiqi & Sun, Licheng, 2025. "Maxing out short-term reversals in weekly stock returns," Journal of Empirical Finance, Elsevier, vol. 82(C).
  • Handle: RePEc:eee:empfin:v:82:y:2025:i:c:s0927539825000301
    DOI: 10.1016/j.jempfin.2025.101608
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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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