Short-Term Return Reversal: The Long and the Short of It

35 Pages Posted: 15 Mar 2012 Last revised: 6 Dec 2012

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

Date Written: September 25, 2012

Abstract

Stock returns unexplained by “fundamentals”, such as cash flow news, are more likely to reverse in the short run than those linked to fundamental news. Making novel use of analyst forecast revisions to measure cash flow news, a simple enhanced reversal strategy generates a risk-adjusted return four times the size of the standard reversal strategy. Importantly, isolating the component of past returns not driven by fundamentals provides a cleaner setting for testing existing theories of short-term reversals. Using this approach, we find that both liquidity shocks and investor sentiment contribute to the observed short term reversal, but in different ways: Specifically, the reversal profit is attributable to liquidity shocks on the long side as fire sales more likely demand liquidity; and it is attributable to investor sentiment on the short side as short-sale constraints prevent the immediate elimination of overvaluation.

Keywords: Short run reversal, liquidity, sentiment, fundamental news

JEL Classification: G12

Suggested Citation

Da, Zhi and Liu, Qianqiu and Schaumburg, Ernst, Short-Term Return Reversal: The Long and the Short of It (September 25, 2012). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2022061 or http://dx.doi.org/10.2139/ssrn.2022061

Zhi Da (Contact Author)

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

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

33 Liberty Street
New York, NY 10045
United States

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