Decomposing Short-Term Return Reversal

45 Pages Posted: 13 Sep 2011

See all articles by Zhi Da

Zhi Da

University of Notre Dame - Mendoza College of Business

Qianqiu Liu

University of Hawaii at Manoa - Shidler College of Business

Ernst Schaumburg

Federal Reserve Banks - Federal Reserve Bank of New York

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2011

Abstract

The profit to a standard short-term return reversal strategy can be decomposed analytically into four components: 1) across-industry return momentum, 2) within-industry variation in expected returns, 3) under-reaction to within-industry cash flow news, and 4) a residual. Only the residual component, which isolates reaction to recent “nonfundamental” price changes, is significant and positive in the data. A simple short-term return reversal trading strategy designed to capture the residual component generates a highly significant risk-adjusted return three times the size of the standard reversal strategy during our 1982-2009 sampling period. Our decomposition suggests that short-term return reversal is pervasive, much greater than previously documented, and driven by investor sentiment on the short side and liquidity shocks on the long side.

Keywords: return reversal, liquidity

JEL Classification: G12, D40

Suggested Citation

Da, Zhi and Liu, Qianqiu and Schaumburg, Ernst, Decomposing Short-Term Return Reversal (September 1, 2011). FRB of New York Staff Report No. 513. Available at SSRN: https://ssrn.com/abstract=1926851 or http://dx.doi.org/10.2139/ssrn.1926851

Zhi Da

University of Notre Dame - Mendoza College of Business ( email )

Notre Dame, IN 46556-5646
United States

Qianqiu Liu

University of Hawaii at Manoa - Shidler College of Business ( email )

2404 Maile Way, E602f
Honolulu, HI 96822
United States
808-956-8736 (Phone)
808-956-9887 (Fax)

Ernst Schaumburg (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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