Overreaction Evidence from Large-Cap Stocks

Review of Accounting and Finance, Forthcoming

26 Pages Posted: 25 Jul 2014 Last revised: 23 Jun 2015

See all articles by Tibebe A. Assefa

Tibebe A. Assefa

Kentucky State University; Bowie State University

Omar A. Esqueda

Tarleton State University - Department of Accounting, Finance, & Economics

Emilios C. Galariotis

Audencia Business School ; Audencia Nantes School of Management

Date Written: November 13, 2013

Abstract

Purpose – The purpose of this paper is to assess the performance of a contrarian investment strategy focusing on frequently traded large-cap U.S. stocks. We address previous criticisms that losers’ gains are not due to overreaction but due to their tendency to be thinly traded and smaller-sized firms than winners.

Design/Methodology/Approach – We construct portfolios based on past performance and examine whether contrarian returns exist. We employ the Capital Asset Pricing Model (CAPM), Fama and French three-factor model and the Carhart’s (1996) momentum portfolio to test whether excess returns are feasible in a contrarian strategy.

Findings – The results show an asymmetric performance following portfolio formation. Whereas both, winners and losers portfolios, have gains during holding periods, losers outperform winners at all times, and with a differential of up to 29.2% thirty-six months after portfolio formation. Furthermore, the loser and the winner portfolios’ alphas are significant, suggesting that the CAPM and the multifactor models are unable to explain return differentials between winners and losers. Our evidence supports two main conclusions. First, stock market overreaction still holds for a sample of large firms. Second, this is robust to the Fama and French (1993, 1996) three-factor model and Carhart (1997) momentum portfolio. Our findings emphasize the relevance of a contrarian strategy when rebalancing investment portfolios.

Practical Implications – Portfolio managers can improve stock returns by selling past winners and buying previous loser large-cap U.S. stocks.

Originality/Value – This paper is the first, to the authors' knowledge, to examine frequently traded large cap U.S. stocks in order to avoid infrequent trading and size concerns.

Keywords: Overreaction, CAPM, Stock Market Anomaly, Three-factor model

JEL Classification: G11, G12, G14

Suggested Citation

Assefa, Tibebe Abebe and Assefa, Tibebe Abebe and Esqueda, Omar A. and Galariotis, Emilios C., Overreaction Evidence from Large-Cap Stocks (November 13, 2013). Review of Accounting and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2470753

Tibebe Abebe Assefa (Contact Author)

Kentucky State University ( email )

400 E. Main St.
School of Business
Frankfort, KY 40601
United States

Bowie State University ( email )

14000 Jericho Park Rd
Bowie, MD 20715-9465
United States

Omar A. Esqueda

Tarleton State University - Department of Accounting, Finance, & Economics ( email )

Stephenville, TX 76402
United States
(254)968-9908 (Phone)

HOME PAGE: http://tarleton.edu

Emilios C. Galariotis

Audencia Business School ( email )

8 Road Joneliere
BP 31222
Nantes Cedex 3, 44312
France

HOME PAGE: http://faculte-recherche.audencia.com/en/faculty/faculty-member-cvs/emilios-galariotis/

Audencia Nantes School of Management ( email )

France

HOME PAGE: http://faculte-recherche.audencia.com/en/faculty/faculty-member-cvs/emilios-galariotis/

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