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A large number of studies, predominantly U.S.-based, document predictability in equity returns whereby stocks that performed well in the past continue to do so in the future (e.g., Jegadeesh and Titman [1993]; and Chan, Jegadeesh, and Lakonishok [1996]). Such studies are referred to as momentum (relative-strength) studies and document that, for formation/holding periods of 3 to 12 months, purchasing past "winners" and disposing of past "losers" generates statistically significant abnormal returns.
Another group of studies documents that superior returns can be obtained by performing the exact opposite strategy; that is, selling past winners and purchasing past losers (e.g., DeBondt and Thaler [1985, 1987]). Such strategies are referred to as contrarian strategies. The key factor that distinguishes between these two types of trading strategies is that the momentum strategy is based on a holding (ranking) period of 3 to 12 months and contrarian strategies are based on holding (ranking) periods of much longer duration.
Such strategies are a violation of market efficiency in its most basic (weak-form) level. It is not surprising, therefore, that the very nature of the levels of return generated by such strategies has spawned considerable academic debate. Some have argued that the profitability of such strategies can be explained by market microstructure-related effects, such as the use of an inappropriate return-generating model and the size effect (e.g., Conrad and Kaul [1993]; Fama and French [1996]; and Lo and MacKinley [1990]). Others have argued that the profitability of such strategies can be explained by the market's systematic under-/ overreaction to firm specific news (e.g., Chan, Jegadeesh, and Lakonishok [1996]; and DeBondt and Thaler [1985]). Behavioral theories have been advanced as to why investors depart from the paradigm of rational economic behavior and systematically underreact and overreact to corporate news (e.g., Barberis, Shleifer, and Vishny [1998]; Daniel, Hirshleifer, and Subrahmanyan [1998]; and Hong and Stein [1999]). Many of the behavioral theories attempt to explain, within a unified framework, the simultaneous effects of underreacrion at medium-term horizons (momentum) and overreaction at long-term horizons (contrarian) strategies.
Very little research has been conducted on price-momentum strategies outside of the U.S. Liu, Strong, and Xu [1999], who follow the methodology of Jegadeesh and Titman [1993], document profitable price-momentum strategies in the U.K. market that are consistent with...