Re-examining Reversals in Monthly Stock Returns: Post-Discovery, Size-based, and Time-Variation Evidence

Abstract

We re-examine contrarian relative-strength profits in one-month stock returns with a focus on: (1) the post-discovery vs.pre-discovery evidence, (2) size-based variation, and (3) time-series patterns. Over the last two decades since the initial documentation in the academic literature, profits to the one-month relative-strength contrarian strategy appear to have weakened substantially. In fact, reversals for this strategy are only evident for small-cap stocks in the post-discovery sample. Further, we find that the reversal profits are reliably higher following periods of high realized stock market volatility; where, following from Nagel (2012), we interpret the lagged return volatility as a state variable that indicates time-variation in the return to liquidity provision. We also find that the reversals are much stronger in January for both the pre-and post-discovery periods. For the post-discovery period, only the small-cap stocks exhibit reliable reversals for the non-January months. Our collective findings suggests that the one-month relative-strength strategy can be characterized as a weakening illiquidity-related phenomenon.

Keywords: contrarian strategies, monthly stock returns, January seasonality

JEL Classification: G14