Noise Trading, Slow Diffusion of Information, and Short-Term Reversals: A Fundamental Analysis Approach

43 Pages Posted: 10 Jan 2018 Last revised: 17 May 2018

See all articles by Zhaobo Zhu

Zhaobo Zhu

Shenzhen Audencia Business School - Shenzhen University; Audencia Business School

Licheng Sun

Old Dominion University

Min Chen

San Francisco State University - Department of Accounting

Date Written: May 10, 2018

Abstract

Contrary to the conventional wisdom that short-term return reversals are rooted in investors’ overreaction to fundamental news or driven by liquidity-based noninformational shocks alone, we find strong evidence that both noise trading and investor underreaction to fundamental information contribute to the reversal. With help from a comprehensive and nonparametric measure of firms’ fundamental strength, we document that an enhanced short-term reversal strategy that buys past losers with strong fundamentals and sells past winners with weak fundamentals significantly outperforms the unconditional reversal strategy. Our findings are consistent with the predictions of theoretical models where investors underreact to slowly diffusing fundamental information.

Keywords: short-term return reversals, fundamental analysis, investor underreaction, slow diffusion of information

JEL Classification: G11, G12, G14

Suggested Citation

Zhu, Zhaobo and Sun, Licheng and Chen, Min, Noise Trading, Slow Diffusion of Information, and Short-Term Reversals: A Fundamental Analysis Approach (May 10, 2018). Available at SSRN: https://ssrn.com/abstract=3097420 or http://dx.doi.org/10.2139/ssrn.3097420

Zhaobo Zhu (Contact Author)

Shenzhen Audencia Business School - Shenzhen University ( email )

3688 Nanhai Road, Nanshan District
Shenzhen, Guangdong 518060
China

Audencia Business School ( email )

8 Road Joneliere
BP 31222
Nantes Cedex 3, 44312
France

Licheng Sun

Old Dominion University ( email )

Strome College of Business
Department of Finance
Norfolk, VA 23529-0222
United States

Min Chen

San Francisco State University - Department of Accounting ( email )

United States

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