Testing the Profitability of Contrarian Trading Strategies Based on the Overreaction Hypothesis

We develop 200 contrarian trading strategies based on significant market variations to test whether it is possible to benefit from the well-known psychological bias of overreaction that plagues investors. We conduct the most recent and appropriate statistical tests to ensure that none of these active strategies beats the buy-and-hold strategy due to pure luck only. Each of these strategies are tested on 13 different underlying assets, including exchange rates and stock indexes. When both transaction and borrowing costs are taken into account, our empirical results suggest that the use of significant market variations as daily reversal signals does not lead to any abnormal profit.
JEL Codes: G14

Keywords: Return Predictability; High Market Variation; Overreaction; Behaviorial Bias; SSPA.