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Overreaction: the sensitivity of defining the duration of the formation period

Prior research provides evidence suggesting that losers tend to continue to be losers in the short and medium term, whereas there is evidence showing that losers outperform winners in the long term. However, there are some differences in methodology used in the studies, particularly in their definition of the duration of the formation period as well as the definition of returns. This paper aims to investigate the underreaction/overreaction hypothesis and in particular to examine the sensitivity of defining the duration of the formation period. The results confirm that losers tend to continue to be losers when cumulative excess return is calculated over short and medium periods. There is evidence, however, suggesting that losers outperform winners when cumulative excess returns are calculated over a long period, even after six months up to five years of portfolio formation. Furthermore, the results show that neither the size effect nor the January effect has a role in explaining the difference in returns between winners and losers. Moreover, the difference in returns between winners and losers cannot be attributed to change in risk or to change in illiquidity. However, I provide evidence that some part of the winner–loser effect can be attributed to leverage effect.