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Overreaction and the Cross-Section of Returns: International Evidence

Last Updated on 10 February, 2024 by Rejaul Karim

The scholarly work titled “Overreaction and the Cross-Section of Returns: International Evidence” delves into a comprehensive exploration of the interplay between price momentum and reversals in global equity returns.

Authored by Douglas W. Blackburn from JP Morgan Chase and Nusret Cakici from Fordham University, this research paper scrutinizes the behavioral underpinnings of these phenomena, encapsulating the complex interactions between rational and irrational investor behavior. Within this ambit, the study signals a noteworthy absence of large-scale global investigations into the enduring implications of long-term price reversals, thus paving the way for a pioneering investigation into returns across twenty-three developed countries.

Unveiling compelling evidence supporting the pervasive presence of long-term price reversals, this incisive analysis underscores the economic and statistical significance of the positive return differentials between loser and winner stocks.

Ultimately, this study’s groundbreaking findings bear testament to the enduring impact of long-term reversals, even in the face of size, book-to-market equity, and momentum considerations, offering invaluable insights into international asset pricing and market efficiency.

Abstract Of Paper

Theory has linked price momentum with price reversals (Barberis, Shleifer, and Vishny (1998), Daniel, Hirshleifer, and Subrahmanyam (1998), and Hong and Stein (1999)). The models generally rely on behavioral descriptions of irrational investors who push prices beyond their fundamental value thus leading to an inevitable price reversal. While significant empirical evidence has shown the presence of momentum in global equity returns, there have been no large-scale global studies of the subsequent long-term price reversals. We study returns from twenty-three developed countries categorized into the regions of North America, Europe, Japan, and Asia, over 1993-2014 and find evidence supporting the global presence of long-term price reversal. The positive return differential between loser stocks over the past three years and winner stocks over the past three years is economically and statistically significant. Results from independent double sorts and from Fama-MacBeth regressions show that long-term reversals remains significant after controlling for size, book-to-market equity, and momentum.

Original paper – Download PDF

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Author

Douglas W. Blackburn
JP Morgan Chase

Nusret Cakici
Fordham university

Conclusion

In “Overreaction and the Cross-Section of Returns: International Evidence,” Douglas W. Blackburn and Nusret Cakici masterfully unravel the intricate tapestry of price momentum and reversals within the global equity landscape.

Their groundbreaking study unveils an undeniable global prevalence of long-term price reversal, as evidenced by the economically and statistically significant positive return differentials between loser and winner stocks over the past three years.

Notably, the resilience of long-term reversals, even after meticulous controls for size, book-to-market equity, and momentum, underscores the enduring impact and importance of these phenomena in shaping international asset pricing.

This seminal work not only enriches our understanding of return predictability, overreaction, and market efficiency but also beckons future research to expand and build upon the profound insights into the intricate cross-section of returns in the international arena.

Related Reading:

Long-Term Return Reversal: Evidence from International Market Indices

A Lottery Demand-Based Explanation of the Beta Anomaly

FAQ

What is the focus of the paper “Overreaction and the Cross-Section of Returns: International Evidence”?

The paper focuses on the interplay between price momentum and reversals in global equity returns. Specifically, it explores the behavioral underpinnings of these phenomena, investigating the presence of long-term price reversals in global equity returns across twenty-three developed countries.

What is the theoretical background linking price momentum with reversals?

Theoretical models have linked price momentum with reversals, relying on behavioral descriptions of irrational investors who may push prices beyond their fundamental value, leading to an inevitable price reversal. This theoretical background is referenced in works by Barberis, Shleifer, and Vishny (1998), Daniel, Hirshleifer, and Subrahmanyam (1998), and Hong and Stein (1999).

What is the key evidence presented in the study?

The study provides compelling evidence supporting the global presence of long-term price reversals. It highlights the economically and statistically significant positive return differentials between loser stocks over the past three years and winner stocks over the past three years in global equity returns.

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