THE MONETARY ENVIRONMENT AND LONG-RUN REVERSALS IN STOCK RETURNS

Authors


  • The authors acknowledge helpful comments received from an associate editor, an anonymous referee, and Werner DeBondt, Richard DeFusco, Sanjay Deshmukh, Art Durnev, Keith Gamble, Jon Garfinkel, John Geppert, Wei Li, Jeff Madura, Amrita Nain, Manferd Peterson, Yiming Qian, Ashish Tiwari, Emre Unlu, Anand Vijh, Tong Yao, and Tom Zorn. In addition, the paper benefited from comments received from seminar participants at the University of Iowa, DePaul University, the University of Nebraska–Lincoln, Northern Illinois University, and at the meetings of the 2012 Financial Management Association (Atlanta, GA). All errors and omissions are our own.

Abstract

Previous research attributes long-run reversals to investor overreaction or tax-motivated trading; we offer an alternative explanation based on the monetary environment. Prices rebound for stocks that have performed poorly over the past several years (losers); however, the rebound occurs only during expansive monetary conditions. Winners only reverse course when monetary conditions are restrictive. Past research shows that the three-factor model explains long-run stock reversals; we show that the monetary environment plays an instrumental role in the observation. Finally, we show that reversal patterns are closely linked to both the monetary environment and a firm's level of financial constraints.

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