The Contrarian Strategy in the Spanish Stock Market
44 Pages Posted: 2 Jan 2001
Date Written: September 2000
One of the most important topics in financial literature is the market efficiency hypothesis. In the last couple of decades, most studies have questioned this hypothesis and several authors have shown that the contrarian strategy, or the forming of a zero-investment portfolio that buys the stocks that have performed poorly in the past (losers) and sells those that have performed well (winners), creates abnormally positive returns in the future. Many hypotheses have been suggested in an attempt to explain such strange behaviour by the market, but the most widely discussed is the so-called over-reaction effect. In this paper we analyse the contrarian strategy in the empirical context of the Spanish stock market, using three-year periods, not only to form the portfolios of winners and losers, but also to analyse the future performance of the stocks involved. We employ an arithmetical method to evaluate the returns and the buy-and-hold procedures. We follow the methods proposed by De Bondt and Thaler (1985), Chan (1988), Conrad and Kaul (1993) and Ball and Kothari (1989). By using these procedures, we are able to take the risk and the problems linked with the measurement errors into account. We arrive at the conclusion that, with the use of three-year periods, the contrarian strategy does not beat the market and, therefore, no over-reaction effect is observed in the Spanish stock market. These results, however, do not agree with previous evidence published on this market.
Keywords: Efficiency, overreaction, risk, beta
JEL Classification: G14, G11, G12
Suggested Citation: Suggested Citation