Consistent winners and losers

This paper investigates two related questions. First, I examine whether a string of relatively high (low) stock return performance that is measured over short periods ranging from the past two to four months triggers a market overreaction that gradually reverts to fundamentals. Second, I assess whether these two mispricing patterns, i.e., the momentum and reversal effects, are empirically linked. Results reported in this paper show that a zero-investment strategy that is long on consistent winners and short on consistent losers earns substantial average monthly abnormal returns that continue to be economically and statistically significant over the next twelve months. Subsequently, however, the return for the zero-investment portfolio in Years 2 to 5 is negative, resulting in a reversal of the bulk of the initial momentum profit. This evidence suggests that the return momentum and the price reversal anomalies are likely to be driven by the same investor psychology. This finding remains robust to the four-factor regression (the Fama-French three-factor model extended by the momentum factor) and various sensitivity tests. My evidence is consistent with the spirit of the psychology-based models.