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When Are Contrarian Profits Due to Stock Market Overreaction?

Andrew W. Lo¹; A. Craig MacKinlay²

¹ Sloan School of Management, M.I.T., 50 Memorial Drive, Cambridge, MA 02139, USA · ² University of Pennsylvania

If returns on some stocks systematically lead or lag those of others, a portfolio strategy that sells “winners” and buys “losers” can produce positive expected returns, even if no stock’s returns are negatively autocorrelated as virtually all models of overreaction imply. Using a particular contrarian strategy we show that, despite negative autocorrelation in individual stock returns, weekly portfolio returns are strongly positively autocorrelated and are the result of important cross-autocorrelations. We find that the returns of large stocks lead those of smaller stocks, and we present evidence against overreaction as the only source of contrarian profits.

DOI

10.1093/rfs/3.2.175

Volume

3 (2)

Pages

175-205

Language

en

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Sources

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