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Long-Term, Short-Term and Time-Varying Profitability of Reversals: The Role of Market State and Volatility

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  • Ali Fayyaz Munir
  • Shahrin Saaid Shaharuddin
  • Mohd Edil Abd. Sukor

Abstract

Purpose: The purpose of this paper is to investigate the various patterns of contrarian trading strategy that can generate superior returns for retail investors in Pakistan Stock Exchange (PSX). Design/Methodology/Approach: To examine the long-term and short-term pattern of contrarian anomaly, the study adopts the buy-and-hold method and j-k overlapping portfolio formation procedure of Jegadeesh and Titman with slight modifications. Moreover, the study is also carried out to investigate the relation between the performance of contrarian portfolios and several market conditions to further test if the time-varying contrarian effects are context-dependent. Findings: The study findings suggest the existence of both long-term and short-term reversal effects that vary over time. Interestingly, the contrarian strategies yield higher returns during crisis periods, negative market state and higher market volatility. We show that short-term reversals, thus the payoffs to contrarian strategy, are predictable with market state which is found to be the primary predictor. The overall findings of this research lend partial support to the Adaptive Market Hypothesis (AMH) which claims that the changed stock market conditions are the main causes of time-varying behavior of market efficiency. Practical Implications: The existing literature reveals that the unchecked stock market intermediaries in PSX artificially manipulate the stock prices and earn abnormal returns at the expense of momentum or uninformed investors. The current research enables the policy makers and regulators to understand why emerging equity markets fail due to manipulations and how unsheltered investors can survive under the weak governing environment. Originality/Value: This study contributes to the existing literature on asset pricing by innovating various ways of excess returns based on contrarian trading strategy. In addition, our work contributes to the literature on the AMH by testing the impact of several stock market conditions on the time-varying profitability of contrarian strategy. There is a dearth of literature on the conditioning impact of various market states on the time-varying behavior of trading strategies in emerging markets.

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  • Ali Fayyaz Munir & Shahrin Saaid Shaharuddin & Mohd Edil Abd. Sukor, 2020. "Long-Term, Short-Term and Time-Varying Profitability of Reversals: The Role of Market State and Volatility," International Journal of Economics & Business Administration (IJEBA), International Journal of Economics & Business Administration (IJEBA), vol. 0(2), pages 501-520.
    • Handle: RePEc:ers:ijebaa:v:viii:y:2020:i:2:p:501-520
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    Cited by:

    1. Ali Fayyaz Munir & Mohd Edil Abd. Sukor & Shahrin Saaid Shaharuddin, 2022. "Adaptive Market Hypothesis and Time-varying Contrarian Effect: Evidence From Emerging Stock Markets of South Asia," SAGE Open, , vol. 12(1), pages 21582440211, January.
    2. Ali Fayyaz Munir & Shahrin Saaid Shaharuddin & Mohd Edil Abd Sukor & Mohamed Albaity & Izlin Ismail, 2021. "Financial liberalization and the behavior of reversals in emerging market economies," International Journal of Emerging Markets, Emerald Group Publishing Limited, vol. 17(6), pages 1565-1582, January.

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    More about this item

    Keywords

    Emerging markets; contrarian theory; contrarian payoffs; EMH; AMH; market hypotheses.;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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