Funding Conditions and the Long-Run Reversal in Stock Returns
45 Pages Posted: 18 Mar 2011 Last revised: 20 Dec 2011
Date Written: December 15, 2011
Previous research attributes long-run reversals to investor over-reaction or tax-motivated trading; we offer an alternative explanation based on aggregate funding conditions. Our evidence shows that prices rebound for stocks that have performed poorly over the past several years (Losers); however, the rebound occurs only during favorable funding environments. In contrast, stocks exhibiting strong long-term past performance (Winners) only reverse course if funding conditions are unfavorable. Past research shows that the three-factor model explains long-run stock reversals; we find that funding conditions play an instrumental role in this observation. Specifically, small, distressed Losers reverse substantially, but only when funding conditions are unconstrained. In contrast, small Winners reverse significantly, but only when funding is constrained. Finally, we show that the reversal pattern is closely linked to both the funding environment and a firm’s level of financial constraints, which suggests that both factors influence investor pricing decisions for Losers and Winners.
Keywords: Long-run price reversals, funding conditions, monetary policy
JEL Classification: G12, G14, E52
Suggested Citation: Suggested Citation