Quantitative Momentum Research: Long-Term Return Reversal

////Quantitative Momentum Research: Long-Term Return Reversal

Quantitative Momentum Research: Long-Term Return Reversal

By |2017-10-26T11:37:43+00:00January 9th, 2015|Momentum Investing Research|

Does the Stock Market Overreact?


Research in experimental psychology suggests that, in violation of Bayes’ rule, most people tend to “overreact” to unexpected and dramatic news events. This study of market efficiency investigates whether such behavior affects stock prices. The empirical evidence, based on CRSP monthly return data, is consistent with the overreaction hypothesis. Substantial weak form market inefficiencies are discovered. The results also shed new light on the January returns earned by prior “winners” and “losers.” Portfolios of losers experience exceptionally large January returns as late as five years after portfolio formation.

Core Idea:

De Bondt and Thaler (1985) reject the market efficiency hypothesis by stating that investors “overreact” to unexpected information. Stocks that experience extreme returns may have subsequent price reversals and such reversals persist in the long-term (3-5 years). They propose that “Contrarian Strategies,” which buy past losers (undervalued stocks) and sell past winners (overvalued stocks), will generate abnormal returns.

Their main findings are the following:

  1. Overreaction Phenomenon: Extreme price movements in the formation period will be followed by subsequent opposite price movement direction. The more (or less) extreme return experiences, the greater (or smaller) will be the subsequent reversals.
    • To test such reversal, the authors compute each stock’s cumulative excess returns (CU) for the prior 36 months starting in Dec 1932. The step is repeated 16 times for all nonoverlapping 3-year period between Jan 1930 and Dec 1977. On each of the 16 relevant portfolio formation dates (Dec 1932, Dec 1935,…, Dec 1977), the CUs are ranked from low to high. Firms in the top 35 stocks are assigned to winner portfolios, and firms in the bottom 35 stocks to the loser portfolios.
    • Below graph shows that “losers” based on past 16 nonoverlapping three-year formation period outperform “winners” by 24.6% over the next 3 years. Separately, losers outperform the market by 19.6%, on average, over the next thirty-six months (3 years) after portfolio formation. Winners, on the other hand, earn about 5% less than the market.
  2. For a formation as short as one year, no reversal is observed.
  3. A large proportion of the future outperformance of past long-term losers over past long-term winners is found in January.
  4. The winner portfolio has a higher CAPM Beta (1.369) than the loser portfolio (1.026).
2014-11-12 16_17_24-Momentum academic Research recap_V01.pptx - Microsoft PowerPoint (Product Activa

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

  • The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).
  • Join thousands of other readers and subscribe to our blog.
  • This site provides NO information on our value ETFs or our momentum ETFs. Please refer to this site.

About the Author:

Jack Vogel, PhD
Jack Vogel, Ph.D., conducts research in empirical asset pricing and behavioral finance, and is a co-author of DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His dissertation investigates how behavioral biases affect the value anomaly. His academic background includes experience as an instructor and research assistant at Drexel University in both the Finance and Mathematics departments, as well as a Finance instructor at Villanova University. Dr. Vogel is currently a Managing Member of Alpha Architect, LLC, an SEC-Registered Investment Advisor, where he heads the research department and serves as the Chief Financial Officer. He has a PhD in Finance and a MS in Mathematics from Drexel University, and graduated summa cum laude with a BS in Mathematics and Education from The University of Scranton.
Yes No
This website uses cookies and third party services. Settings Ok


We use “cookies” on this site. A cookie is a piece of data stored on a site visitor’s hard drive to help us improve your access to our site and identify repeat visitors to our site. For instance, when we use a cookie to identify you, you would not have to log in a password more than once, thereby saving time while on our site. Cookies can also enable us to track and target the interests of our users to enhance the experience on our site. Usage of a cookie is in no way linked to any personally identifiable information on our site. Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies.

Embedded Content

Articles on this Site may include embedded content (e.g. videos, images, articles, etc.). Embedded content from other websites behaves in the exact same way as if the visitor has visited the other website.These websites may collect data about you, use cookies, embed additional third-party tracking, and monitor your interaction with that embedded content, including tracking your interaction with the embedded content if you have an account and are logged in to that website.