Contrarian profits of the firm-specific component on stock returns

A weekly contrarian strategy based on residual stock returns provides larger, more significant, and steadier profits than conventional contrarian strategies, which use total returns. We decompose residual return-based contrarian profits by modifying the decomposition methodology in Lo and MacKinlay (1990). This decomposition reveals that the residual return-based contrarian profits are attributed to negative autocovariances in individual residual returns, rather than positive cross-serial covariances across residual returns. We further decompose Lo and MacKinlay's decomposition, and reveal that winners are strongly negatively autocorrelated. In conclusion, investors' overreactions to good firm-specific news are a primary source of residual contrarian profits.