Trading on Overshooting

66 Pages Posted: 10 Jan 2020

See all articles by Min S. Kim

Min S. Kim

Michigan State University - Department of Finance; Financial Research Network (FIRN)

Date Written: December 16, 2019

Abstract

This paper presents novel evidence that individual stocks are subject to mispricing amid shocks that permanently shift the long-run relationship between the price and the fundamentals (e.g., book value). When the long-run level of the price-to-fundamentals ratio increases/decreases, the price is expected to rise/drop during the mean shift. Based on higher/lower expected returns, uninformed investors, however, incorrectly infer that the stock is currently undervalued/overvalued and increase the purchases/sales, which causes mispricing. Trading strategies that exploit subsequent reversals of the returns yield significant positive returns. Buying/shortselling closed-end mutual funds with lowest/highest mean shifts of the price-to-NAV ratio produces risk-adjusted returns of 3% to 8% per year. Overreaction to news might not explain these results.

Keywords: Mispricing, mean shift, price multiple, underreaction, closed-end mutual fund

JEL Classification: G11, G12, G41

Suggested Citation

Kim, Min S., Trading on Overshooting (December 16, 2019). Available at SSRN: https://ssrn.com/abstract=3505076 or http://dx.doi.org/10.2139/ssrn.3505076

Min S. Kim (Contact Author)

Michigan State University - Department of Finance ( email )

315 Eppley Center
East Lansing, MI 48824-1122
United States

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
79
Abstract Views
384
rank
362,013
PlumX Metrics