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Long-term over-reaction in the UK stock market and size adjustments

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  • Kevin Campbell
  • Robin Limmack

Abstract

This study tests for long-term reversals in the abnormal returns of UK companies classified as 'winners' and 'losers' over the period from January 1979 to December 1990 using publicly available data from the London Business School (LBS) Risk Measurement Service. In the first part of the study we find that in the 12 months following portfolio formation 'loser' companies continued to experience negative abnormal returns and 'winner' companies persisted in generating positive abnormal returns, thus appearing to contradict the findings of US studies which support the 'winner-loser' effect. The possible influence of firm size was examined by splitting the 'winner' and 'loser' portfolios into groups based on equity market capitalization. It was found that the very smallest 'loser' companies did experience a reversal in their abnormal returns over the following 12 months, but that no such reversal existed for the smallest 'winner' companies. When the study was extended to cover the five-year period following portfolio formation, it was found that a reversal in the abnormal returns of winner and loser portfolios was experienced over each of years 2-5, thus lending support to the winner-loser effect. Returns of sufficient magnitude were generated from the strategy of short-selling winners and buying losers over this extended period to suggest that the winner-loser effect is an exploitable anomaly. The excess returns remained when companies were matched with control portfolios of similar size, thus suggesting that the long-term 'over-reaction phenomenon' in the UK is not simply a manifestation of the well documented size effect. However, this latter result is also a function of the length of sample selection period. Finally, we report the results of tests which suggest that the phenomenon is seasonal in nature, with the most significant return reversals occurring in January and April for small companies in the loser portfolio. The latter result provides support for the tax-loss selling hypothesis.

Suggested Citation

  • Kevin Campbell & Robin Limmack, 1997. "Long-term over-reaction in the UK stock market and size adjustments," Applied Financial Economics, Taylor & Francis Journals, vol. 7(5), pages 537-548.
    • Handle: RePEc:taf:apfiec:v:7:y:1997:i:5:p:537-548
    DOI: 10.1080/096031097333402
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    Citations

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    Cited by:

    1. Dumitriu, Ramona & Stefanescu, Razvan & Nistor, Costel, 2012. "Reactions of the capital markets to the shocks before and during the global crisis," MPRA Paper 41540, University Library of Munich, Germany, revised 10 Jan 2012.
    2. Carlos Forner & Joaquín Marhuenda, 2003. "Contrarian and Momentum Strategies in the Spanish Stock Market," European Financial Management, European Financial Management Association, vol. 9(1), pages 67-88, March.
    3. Walid Saleh, 2007. "Overreaction: the sensitivity of defining the duration of the formation period," Applied Financial Economics, Taylor & Francis Journals, vol. 17(1), pages 45-61.
    4. Daske, Stefan, 2002. "Winner-Loser-Effekte am deutschen Aktienmarkt," SFB 373 Discussion Papers 2002,87, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    5. Olfa Chaouachi & Fatma Wy?me Ben Mrad Douagi, 2014. "Overreaction Effect in the Tunisian Stock Market," Journal of Asian Business Strategy, Asian Economic and Social Society, vol. 4(11), pages 134-140, November.
    6. Plastun, Alex & Sibande, Xolani & Gupta, Rangan & Ji, Qiang, 2024. "Price effects after one-day abnormal returns and crises in the stock markets," Research in International Business and Finance, Elsevier, vol. 70(PA).
    7. Recep Bildik & Güzhan Gülay, 2007. "Profitability of Contrarian Strategies: Evidence from the Istanbul Stock Exchange," International Review of Finance, International Review of Finance Ltd., vol. 7(1‐2), pages 61-87, March.
    8. Plastun, Alex & Sibande, Xolani & Gupta, Rangan & Wohar, Mark E., 2021. "Evolution of price effects after one-day abnormal returns in the US stock market," The North American Journal of Economics and Finance, Elsevier, vol. 57(C).
    9. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, June.
    10. McSweeney, Brendan, 2009. "The roles of financial asset market failure denial and the economic crisis: Reflections on accounting and financial theories and practices," Accounting, Organizations and Society, Elsevier, vol. 34(6-7), pages 835-848, August.
    11. Supriya Maheshwari & Raj S. Dhankar, 2017. "Profitability of Volume-based Momentum and Contrarian Strategies in the Indian Stock Market," Global Business Review, International Management Institute, vol. 18(4), pages 974-992, August.
    12. Dimitris Kenourgios & Nikolaos Pavlidis, 2005. "Individual Analysts’ Earnings Forecasts: Evidence for Overreaction in the UK Stock Market," Finance 0512011, University Library of Munich, Germany.
    13. Lasfer, M. Ameziane & Melnik, Arie & Thomas, Dylan C., 2003. "Short-term reaction of stock markets in stressful circumstances," Journal of Banking & Finance, Elsevier, vol. 27(10), pages 1959-1977, October.
    14. Mai, Nhat Chi, 2020. "Behaviours In The Stock Market - An Empirical Study," OSF Preprints ypq8m, Center for Open Science.
    15. Mengoli, Stefano, 2004. "On the source of contrarian and momentum strategies in the Italian equity market," International Review of Financial Analysis, Elsevier, vol. 13(3), pages 301-331.
    16. Muhammad Kashif & Sanyah Saad & Imran Umer Chhapra & Farhan Ahmed, 2018. "An Empirical Evidence of Over Reaction Hypothesis on Karachi Stock Exchange (KSE)," Asian Economic and Financial Review, Asian Economic and Social Society, vol. 8(4), pages 449-465, April.
    17. Hisham Farag, 2015. "Long-term Overreaction, Regulatory Policies and Stock Market Anomalies: Evidence from Egypt," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 14(2), pages 112-139, August.
    18. Supriya Maheshwari & Raj S. Dhankar, 2018. "Market State and Investment Strategies: Evidence from the Indian Stock Market," IIM Kozhikode Society & Management Review, , vol. 7(2), pages 154-170, July.

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