Long-term return reversals—Value and growth or tax? UK evidence

Abstract

a b s t r a c tThis paper examines (i) whether value-growth characteristics have more power than past performance in predicting return reversals; and (ii) whether typical rational behaviour such as incentives to delay paying capital gain taxes can better explain long-term reversals than past performance. We find that value-growth characteristics generally provide better explanations for long-term stock returns than past performance. The evidence also shows that winners identified by capital gains dominate past performance winners in predicting reversals in the cross-sectional comparison. However, in the time-series analysis, when returns on capital gain winners are adjusted by the Fama and French (1996) risk factors, the predictive power of capital gain winners disappears. Our results show that capital gain winners are heavily featured as growth stocks. Return reversals in capital gain winners potentially reflect market price corrections for growth stocks. We conclude that investors' incentives to delay paying capital gain taxes cannot fully rationalise long-term reversals in the UK market. Our results also imply that the long-term return pattern potentially reflects a mixture of investor rational and irrational behaviour.

Long-term industry reversals

“…9 , plus the return from 6 Details on the screening procedures are provided in Appendix A1. 7 While Clare and Thomas (1995) employ a random sample of 1,000 UK stocks, Wu and Li (2011) use 1,745 UK stocks that are constituents of the FTSE All Share Index. 8 The ICB system is a commonly used industry classification outside the US markets.…”

Do Low‐Priced Stocks Drive Long‐Term Contrarian Performance on the London Stock Exchange?

“…Antoniou, Galariotis and Spyrou (2006) use weekly data of 1,645 LSE stocks and find that contrarian performance exists in the U.K. market where large capitalization stocks are the main driving force for contrarian performance. Wu and Li (2011) use constituent stocks in the FTSE All‐Share Index from 1979 to 2009 in the United Kingdom and investigate whether delaying capital gain tax payment can explain winner reversals. They find that growth stocks, rather than stocks with a large amount of capital gains, drive winner reversals over the long term.…”

“…Since DeBondt and Thaler's (1985) finding that past losers outperform past winners, long‐term contrarian performance has been reported across both developed and developing markets (Clare and Thomas, 1995; Dissanaike, 1997; Antoniou, Galariotis and Spyrou, 2005; Wongchoti and Pyun, 2005; Chou, Wei and Chung, 2007; McInish, Ding and Pyun, 2008; Wu and Li, 2011). While the existence of contrarian performance is generally accepted, explaining its cause and identifying its source have been more controversial.…”

Do Low-Priced Stocks Drive Long-Term Contrarian Performance on the London Stock Exchange?

“…Since the DeBondt and Thaler's (1985) finding of past losers outperforming past winners, long term contrarian performance has been reported across both developed and developing markets (Clare and Thomas, 1995;Dissanaike, 1997;Wongchoti and Pyun, 2005;Antoniou et al, 2005;Chou et al, 2007;McInish et al, 2008;Wu and Li, 2011). While the existence of contrarian performance is generally accepted, explaining the cause of and identifying the source of contrarian performance have been more controversial.…”