Staff Reports
Decomposing Short-Term Return Reversal
2014   September 2011  Number 513
JEL classification: G12, D40

Authors: Zhi Da, Qianqiu Liu, and Ernst Schaumburg

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.

Available only in PDF pdf  45 pages / 619 kb
For a published version of this report, see Zhi Da, Qianqiu Liu, and Ernst Schaumburg, "A Closer Look at the Short-Term Return Reversal," Management Science 60, no. 3 (March 2014): 658-74.
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