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Overreaction and underreaction in the UK

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Resumo:In this research work we challenge the Efficient Market Hypothesis (EMH) of Fama (1970) in its weak-form by assessing if price and earnings momentum and reversals are robust in the UK stock market over December 1985 to June 2016; and whether these phenomena can be explained by behavioral finance theory regarding the Underreaction and Overreaction Hypothesis. We analyze the short- and long-term profitability of momentum strategies by forming and testing relative strength portfolios based either on price and earnings variables. Our results indicate that the profits from momentum strategies have generated consistently superior returns as those achieved by the overall market for the last 31 years in the UK; and that momentum can be largely attributed to extreme past winners’ stocks that have suffer from favorable earnings surprises. After controlling for risk, extreme past winners’ stocks exhibit steady positive abnormal returns and extreme past losers’ stocks tend to exhibit normal performance. Evidence provided is consistent with the argument that momentum profits are not explained by asset pricing models as FamaFrench (1993) three-factor model and Carhart (1997) four-factor model; and with the argument that the Fama-French (1993) three-factor model is effective in explaining the tendency for stock returns to reverse. We confirm the existence of stock price relation between stock price momentum and market underreaction to firm-specific information. Multivariate analysis performed point on a systematic drift of stock prices associated with the release of unexpected positive earnings surprises. Our results are compatible with the underreaction hypothesis. We found evidence that investors tend to underweight positive earnings surprises and, consequently, that conservatism bias causes prices to systematically show a continuation pattern and origin momentum profit opportunities of about 1% a month, by means of a multivariate momentum arbitrage procedure based mutually on price and earnings variables. We conclude that momentum effect is persistent and an exploitable anomaly in the UK from December 1985 to June 2016; is robust to riskadjustments; and brought up (at least in part) by the presence of investors that systematically underreact to favorable and unexpected firm-specific information related to earnings.
Autores principais:Santos, Márcio António de Oliveira
Assunto:Momentum Momentum strategies Reversals Earnings surprises Overreaction Underreaction Market efficiency Behavioral finance
Ano:2017
País:Portugal
Tipo de documento:dissertação de mestrado
Tipo de acesso:acesso aberto
Instituição associada:Universidade do Minho
Idioma:inglês
Origem:RepositóriUM - Universidade do Minho

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