Contrarian and Momentum Strategies in Germany

Two traditional methods of managing equity portfolios are investing based on price momentum and value-based contrarian investing. These strategies may be motivated by a behavioral theory of under- and overreaction to news or by empirical research, mostly for the NYSE, that has found persistence in price movements over short horizons and reversion to the mean over longer horizons. However, the apparent success of these strategies may be due to institutional factors and the mismeasurement of risk, or it may result from data mining. For these reasons, we studied all major German companies listed on the Frankfurt Stock Exchange for the three decades between 1961 and 1991. The dynamics of stock prices in Frankfurt are remarkably similar to New York. The data suggest that equity prices reflect investor forecasts of company profits that are predictably wrong. Two traditional methods of managing equity portfolios are investing based on price momentum and value-based contrarian investing. We can justify these strategies with a behavioral theory of under- and overreaction to news or with empirical research for the United States that finds persistence in price movements over short horizons and reversion to the mean over longer horizons. Still, the seeming success of these strategies may be an illusion (the product of data mining), the result of the mismeasurement of risk, or the result of institutional factors that are unique to the United States.We studied all major companies listed on the Frankfurt Stock Exchange for the three decades between 1961 and 1991. We used return and accounting data for 357 firms. Nearly every German company whose name is internationally recognized (e.g., Deutsche Bank, Daimler-Benz, Bayer) was included in the sample. To judge the profitability of momentum strategies, we “bought” portfolios of extreme past winners. We also “sold” short portfolios of extreme past losers. Companies were sorted into winners and losers on the basis of their returns ove(This abstract was borrowed from another version of this item.)