Decomposing short-term return reversal

Zhi Da, Qianqiu Liu and Ernst Schaumburg

No 513, Staff Reports from Federal Reserve Bank of New York

Abstract: The profit to a standard short-term return reversal strategy can be decomposed analytically into four components: 1) across-industry return momentum, 2) within-industry variation in expected returns, 3) under-reaction to within-industry cash flow news, and 4) a residual. Only the residual component, which isolates reaction to recent ?nonfundamental? price changes, is significant and positive in the data. A simple short-term return reversal trading strategy designed to capture the residual component generates a highly significant risk-adjusted return three times the size of the standard reversal strategy during our 1982-2009 sampling period. Our decomposition suggests that short-term return reversal is pervasive, much greater than previously documented, and driven by investor sentiment on the short side and liquidity shocks on the long side.

Keywords: Rate of return; Liquidity (Economics) (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-cba and nep-mst
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Citations: View citations in EconPapers (6)

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