Profitable Mean Reversion after Large Price Drops:

A story of Day and Night in the S&P 500, 400 Mid Cap and
600 Small Cap Indices
By
Jozef Rudy*
Christian L. Dunis**
Jason Laws***
(*Independent Portfolio Manager, **Horus Partners SA, ***University of Liverpool)

August 2010

Abstract
The motivation for this paper is to show the usefulness of the information contained
in the open-to-close (day) and close-to-open (night) periods compared to the more
frequently used close-to-close period. To show this we construct two versions of a
contrarian strategy, where the worst performing shares during the day (resp. night)
are bought and held during the night (resp. day).

We show that the strategies presented here generate a significant alpha and their
returns cannot be solely explained by the factors derived from Fama and French
(1993) 3-factor model and a modified 5-factor model introduced by Carhart (1997).

Even after we account for the bid-ask bounce effect the returns generated are
significant and consistent. The information ratios of the two strategies mentioned for
the entire period 2000-2010 vary between 1.59 and 6.70 depending on the
capitalization of stocks. Overall, we show that opening prices contain information that
is not generally fully utilized yet. The strategy proposed uses this information to add
value and extract a significant alpha which cannot be explained by market factors

Keywords
Price shock, overreaction, delayed reaction, contrarian profits, multi-factor models

____________
*
Jozef Rudy is an independent portfolio manager (E-mail: jozef.rudy@gmail.com) and his investment
results can be found here: https://www.dropbox.com/s/j1b646ytnpitpo1/Results.pdf
**
Christian Dunis is in charge of global risk and new investment products for Horus Partners Wealth
Management Group SA (E-mail: christian.dunis@hpwmg.com)
***
Jason Laws is a lecturer at the department of Economics, Finance and Accounting University of
Liverpool (E-mail: J.Laws@liverpool.ac.uk)

Electronic copy available at: https://ssrn.com/abstract=2272795

 1. INTRODUCTION
The motivation for this study is the existence of contrarian returns which have been
diminishing recently, see e.g. Khandani and Lo (2007). Many papers investigate the
profitability of the contrarian/mean reverting strategies, or strategies of buying losers
and selling winners. But all those papers calculate returns from close-to-close and do
not take opening prices into account. To our knowledge there are no papers
investigating the profitability of the contrarian strategy - where the holding period is
close-to-open (night) or open-to-close (day) instead of a standard close-to-close
period.

The existence of contrarian profits can be partly explained by the overreaction

hypothesis, see e.g. Lo and MacKinlay (1990). A negative autocorrelation in returns
is the common assumption for most overreaction theories, Lo and MacKinlay (1990).
Yet there are also overreaction theories that try to explain the contrarian profits
exclusively after large price falls, see e.g. Choi and Jayaraman (2009). This is a
weaker condition as returns do not even have to be negatively autocorrelated. There
only has to be contrarian profits after large price declines. In this paper we focus
exclusively on this situation and investigate whether in conjunction with the non-
standard holding periods (either day or night) one might obtain an “edge” over other
more traditional strategies.

The rest of the paper is organized as follows. In section 2, we present the literature
review, section 3 describes the data used and section 4 presents the contrarian
strategy. Section 5 gives the performance results of the contrarian strategy and
presents them by decile, by year and proves that the strategy is profitable even after
the inclusion of the bid-ask bounce. In section 6 we try to explain the contrarian
profits by multi-factor models and section 7 concludes.

2. LITERATURE REVIEW

2.1. Predictability of returns

There are various studies on the short- and long-term predictability of stock market
returns [e.g. Thaler and De Bondt (1985), Kim et al. (1991)]. One of the first studies
on the long-term predictability of the individual stock market returns is described in
Thaler and De Bondt (1985). They divide the companies into two groups, extreme
winners and extreme losers, and compare their performance. They form 2 portfolios
(consisting of n worst and n best performing stocks) based on the past 3-year
performance. The portfolios are subsequently rebalanced every 3 years. 3 years
after the portfolio formation they show that the portfolios consisting of the past losers
beat the past winners by 25%. The outperformance continues as late as 5 years
after the portfolios have been formed.

Fama (1997) provides an extensive literature review on long-term market

inefficiencies, nevertheless the author states a few reasons why those papers do not
invalidate the existence of the efficient market hypothesis. The most important one
according to Fama (1997, p. 6) is that most anomalies are “shaky” and tend “to
disappear when reasonable alternative approaches are used to measure them”.

Money managers and hedge funds are more interested in exploiting the short-term
anomalies as opposed to the long-term ones because they need to report investment

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results (e.g. information ratios1) to investors every month or every week. It also takes
much less time to test the short-term anomaly in practice, as one needs to test it
during much shorter time frames which partly motivates our decision to look at the
short-term market reversal anomaly instead of the longer-term one.
2.2. Contrarian strategies
There are two main ways of exploiting the predictability of short-term returns, which
are referred to as the contrarian and momentum strategies. Contrarian strategies
benefit from the overreaction to an isolated event, which results in the trend reversal
and contrarian signs of return after the event as opposed to during the event itself.
On the other hand, momentum strategies benefit from slowly spreading news about
the event among investors, which results in the same sign of returns after the event
as during the event, see Forner and Marhuenda (2003).

McInish et al. (2008) look at the performance of the simple momentum and
contrarian strategies in the seven Pacific-Basin capital markets during 1990-2000.
They find that the contrarian profits are persistent and profitable only in Japan, and
momentum profits are persistent and profitable in Japan and Hong Kong. In the
remainder of this paper however, we focus exclusively on the contrarian strategies.

Serletis and Rosenberg (2009) calculate the Hurst exponent for the four major US
stock market indices during 1971-2006 and find that the returns display anti-
persistent or mean reverting behaviour.

Leung (2009) investigates the return behaviour of the US stocks during 1963-2007.
In his study the shares are first ordered based on past returns and then on market
capitalization. He finds significant short- and long-term mean reverting behaviour of
the returns.
2.3. Overreaction hypothesis
It is important to understand the precise source of the returns when devising a
strategy. The overreaction hypothesis states that extreme movements in the stock
prices are followed by moves in the opposite direction that partly offset the initial
move. The original extreme move is caused by the overreaction to firm-specific
news. However, as in Lo and MacKinlay (1990, p. 116), “a well-articulated
equilibrium theory of overreaction with sharp empirical implications has yet to be
developed”.

Bali et al. (2008) test the non-linear mean reverting behaviour as an alternative
hypothesis to the existence of the random walk and find that the speed of the mean
reversion is higher during periods of large falls in prices.

As to the possibility to profit from extreme price moves, it is enough that stocks that
fell the most during any day bounce back during the subsequent period. They do not
have to bounce back after all the falls and thus do not even have to be negatively
autocorrelated. Therefore a possibility to profit from extreme price movements
caused by the overreaction in individual stock market prices is a weaker condition to
fulfil than the existence of the mean reverting behaviour.

1
In this paper the information ratio is calculated as the ratio of annualized return to annualized
standard deviation, see Appendix a.

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 2.4. Stock returns following large price declines
Gaunt and Nguyen (2008) look at the behaviour of Australian stocks after 5% or
more daily declines. The results suggest that there is a short-term price reversal after
the sharp price decline. Market microstructure (bid-ask bounce) plays an important
role in the short-term price reversal (more on this below). The target stocks continue
to underperform the stock market index during the following 100 days.

Mazouz et al. (2009) use the constituents of the FTSE-ALL Index in the period 1992-
2003. They take the average bid-ask price into account in order to account for a bid-
ask bounce and find a continuation of the return behaviour in the direction of the
shock. Thus, the study finds significant positive returns after a shock of more than
5% and significant negative returns after a negative shock of the same magnitude,
which is in contrast with Choi and Jayaraman (2009).
2.5. Bid-ask bounce effect
The bid-ask bounce is an illusionary effect of a share price change, when there is
actually none. This occurs as the trades occur once at a bid and once at an ask
price. This bears important conclusions upon the short term contrarian strategy. If
the last transaction of the day has occurred at a bid, the first trade the next trading
day at an ask and the bid-ask spread is large for a share, it might seem that there
was a significant rebound when there was actually none. In such case the entire
profitability of the contrarian strategy would be attributable to the existence of a wide
bid-ask spread.

Morse and Ushman (1983) found significant increases in the bid-ask spreads on the
day of a large price change in stocks. Park (1995) looked at the influence of the bid-
ask bounce on the next day’s returns after large price changes. Instead of closing
prices, the author used the average bid-ask price. As a result, previously reported
profitability of a simple strategy based on the price reversal in the close-to-close
period was not found any more after taking TC into account.

Because of the existence of the bid-ask bounce we also show the profitability of a
simple reversal strategy based upon close-to-close returns and compare its results
with our alternative strategies based on different trading frequencies. With the latter,
we obtain much larger and more consistent profits. As a result even if the entire profit
of the close-to-close price reversal strategy is due to the bid-ask bounce and is not
achievable in practice, our strategy can still be profitable due to the far superior
returns achieved.
2.6. Opening gaps and periodic market closures
De Gooijer et al. (2009) try to predict the home market opening price by taking into
account the overnight price pattern of the foreign markets. They find the existence of
non-linear relationships.

Cliff et al. (2008) decompose the market returns of the S&P Index stocks between
day (open-to-close) and night (close-to-open). They investigate the period 1993-
2006 and find that the night returns are strongly positive and the day returns are very
close to 0. They find that the night returns are consistently higher than the day
returns, and this holds across days of the week, weeks of the months and months of
the year. The effect is partly driven by the higher opening prices which decline during
the first trading hour of the session. However, they state that there is not a general

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consensus in the literature whether returns are higher over the trading or non-trading
periods. Cliff et al. (2008, p. 2) affirm that the impact of the periodical market closes
“on the first moment of stock returns is still not fully understood”. This also partly
motivates our decision to look at the contrarian returns during the trading and non-
trading part of the session and see whether they differ from the contrarian profits in
the entire session (close-to-close).

Hong and Wang (2000) investigate how market closures affect investor behaviour.
They find a U-shaped return pattern in the mean and volatility of returns over the
trading periods, more volatile open-to-open returns than close-to-close returns and
contrary to Cliff et al. (2008) higher returns during the trading periods than during the
non-trading periods.

3. RELATED FINANCIAL DATA AND TRANSACTION COSTS

3.1. Data sources

In this paper we use the stocks that constituted the three indices - the S&P 500
Index, the S&P 400 MidCap Index and the S&P 600 SmallCap Index - on 12th
February 2010. The data span from 30 th May 2000 to 12th February 2010, which
amounts to 2353 trading days. We use the opening and closing prices that have
automatically been adjusted for dividends and stock splits by Bloomberg. If a
particular share does not have a price recorded on certain days (e.g. because it was
not listed back then yet), our universe is smaller on these dates.

The price at which the first transaction on a particular day was recorded is the
opening price, and the price at which the last transaction on a particular day was
recorded is the closing price. Thus, we have trade prices at our disposal and will not
consider bid-ask spread in the paper. (However, we show later that our strategy
would not be affected by a bid-ask bounce effect). Nevertheless, we take into
account TC of 0.05% of the transacted amount one way. This is a level charged for
an individual investor2.

While it is possible to trade after hours on the US markets, after-hours trading

introduces lower liquidity and therefore higher bid-ask spreads. In practice our
strategy would preferably be traded in a modified form. One would not wait for a
closing price to make decision, but would execute the transaction a few seconds
before the market closes, basing one’s decision on that particular price. While it is
possible that such a procedure might deteriorate our results as reported in this
paper, it is improbable that a significant part of the profit would be sacrificed by such
a procedure.
3.2. Day and night return characteristics
In this section we present the equally weighted return of the constituent shares of the
3 indices during the day and during the night. The aim is to investigate the
differences in returns which might exist in exclusive daily or nightly ownership of the
constituent shares as already mentioned in Cliff et al. (2008) or Hong and Wang
(2000).

2
For instance see http://interactivebrokers.com/en/p.php?f=commission&ib_entity=llc where the fee is
USD 0.0035 per share, which amounts to 0.05% if the nominal value of share is USD 7. Note that the
fee decreases proportionally as the nominal value of the share increases.

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First, for each share considered we calculate two different return series as:

R1  ln( PDC / PDO ) (1)

R2  ln( PDO1 / PDC ) (2)

where PDC is the closing price of share on day D and PDO is the opening price of share
on day D. From Equation (2), PDO1 is the opening price on day D+1 and PDC is the
closing price on day D.

Subsequently we calculate an equally weighted average daily return across all the
shares belonging to the index (either S&P 500, 400 MidCap or 600 SmallCap) as:
n

R 1
R1  1
(3)
n
n

R 2
R2  1
(4)
n
where R1 is the return series of any share calculated as in Equation (1), n is the
number of shares in any particular index and R1 is an equally weighted average
daily return for the constituent stocks of the index. R2 is the return series of a share
calculated as in Equation (2) and R2 is an equally weighted average daily return.

In such a way we obtain two return distributions for each of the three indices, thus
altogether 6 return distributions.

Index & Period S&P 500 O-C S&P 500 C-O S&P 400 MidCap O-C S&P 400 MidCap C-O S&P 600 SmallCap O-C S&P 600 SmallCap C-O
Avg Return 0.007% 0.007% 0.044% -0.022% 0.040% -0.022%
Median Return 0.051% 0.040% 0.086% 0.007% 0.068% -0.007%
Maximum Return 7.40% 5.64% 8.24% 6.23% 9.14% 5.19%
Minimum Return -9.50% -7.30% -9.27% -8.24% -10.61% -9.14%
St. Dev. 0.0124 0.0071 0.0134 0.0066 0.0145 0.0066
Number of Up Periods 1339 1374 1383 1296 1341 1249
Number of Down Periods 1194 1158 1150 1236 1192 1283
Avg Gain in Up Periods (ex TC) 0.79% 0.40% 0.88% 0.36% 1.00% 0.38%
Avg Loss in Down Periods (ex TC) -0.87% -0.46% -0.97% -0.42% -1.04% -0.41%
Table 1. Trading statistics for various indices. The strategy buys an equal proportion of all the constituent shares in
the index and holds them during the Open-Close or Close-Open period only, respectively.

In Table 1 just above we can see the descriptive statistics of holding the equal
proportion of shares of the mentioned indices either only during night (close-open) or
only during day (open-close).

The mean return of the strategy that buys all the shares that belong to the S&P 500
Index in equal proportion on open of day D and sells them on close of day D is
0.007% (without TC). The generated return would not survive any reasonable level
of TC. The maximum and minimum daily returns are 7.4% and -9.5%, respectively,
over the period considered. The mean return of buying the shares belonging to the

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S&P 500 Index in equal proportion on close of day D and selling them on open of
day D+1 is also 0.007% (without TC), similar to the one shown in the first column.
Maximum and minimum daily returns are 5.6% and -7.3% respectively over the
period considered. Thus, the average return of holding the shares during day and
night is very similar for the constituent stocks of S&P 500 Index and is slightly
positive for both.

In columns 3 and 4 we show the return distribution of the equally weighted

constituent shares of the S&P 400 MidCap Index with holding periods during day and
night, respectively. The average return for daily holding period is 0.0443%, a bigger
number than was the case for the S&P 500 Index, but still too low to be profitable
after the inclusion of TC. The average return for holding the shares only during the
night is -0.0215%. Thus, the daily returns are positive and overnight negative for the
S&P 400 MidCap Index constituents.

In columns 5 and 6 we show the return distribution of the equally weighted

constituent shares of the S&P 600 SmallCap Index. It is similar in magnitude to the
one observed on the constituent shares of the S&P 400 MidCap Index (see columns
3 and 4) and amounts to 0.04% and -0.02%, respectively.

In summary, we obtain results in line with Hong and Wang (2000) as daily returns
are higher than night returns for the 2 of the 3 indices investigated. However, daily
returns are not sufficiently large so that the investor can try to be invested exclusively
during the day. The existence of TC of 0.05% would deem such an intent as
unprofitable. However, the difference between the returns during day and night might
mean that a shorter holding period (either day or night) will make the strategy of
buying extreme losers more profitable compared to holding them during entire
session (24 hours).

4. TRADING STRATEGY
Our strategies attempt to exploit the mean reverting behaviour of the largest losers
either during the day or night.

The first version of the strategy (version 1) buys n worst performing shares during
the close-to-open period (decision period) where close is the closing price today and
open the opening price tomorrow. The shares are bought at the market open
tomorrow for the opening price, held and sold for the closing price tomorrow. The
shares are equally weighted in the portfolio.

The second version of the strategy (version 2) buys n worst performing shares
during the open-to-close period (decision period). The shares are bought when the
market closes, and held until the next day’s market open. They are subsequently
sold for the opening price. The shares are equally weighted in the portfolio.

For comparison we also present the benchmark strategy which consists of buying n
worst shares during an entire session [close (D) - close (D+1)]. The shares are
bought on close (D+1) and held until the next day’s close (D+2). Although the
benchmark strategy only executes transactions at close, it will have the same
amount of transactions as both versions of the strategy described just before. The
only difference is the length of the holding period, where it is the entire session for

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the benchmark strategy (24 hours) and either day or night (7.5 hours or 16.5 hours)
for our 2 versions. For instance, for daily strategy, we buy shares at the market open,
and sell them at the market close. Thus, during entire market session (24 hours) we
have made 2 transactions (buy and sell). The same applies for the benchmark
strategy, where the shares are bought at the close, and sold at the subsequent
market close.

One of the reasons we investigate two daily sub-periods is potentially more difficult
tradability around the market opening time. Although we dispose of the first and last
traded price during the day, it might be impossible to consistently execute
transactions at the official market opening price as is well-known among
practitioners. Therefore, by testing the two versions of the strategy, we can prove
that at least one of them is profitable in practice. The first benefits from lower than
recorded opening price, and the second from higher than recorded opening price. If
both versions of the strategy prove profitable in the backtests, we have shown that in
real trading at least one of them will be making money. In a real trading, consistently
lower/higher opening prices than the ones we used will make version 1 more/less
and version 2 less/more profitable.

5. STRATEGY PERFORMANCE

5.1. Strategy performance by decile

In Table 2 below we summarize the trading statistics of version 1 of the strategy. The
table contains the strategy applied to the constituent stocks of the S&P 600
SmallCap Index. The performance is divided into 10 deciles. The first decile contains
the stocks with the largest decline during the decision period. The tenth decile
contains the stocks with the best performance during the decision period. Thus the
first decile will probably not contain the same shares during two consecutive holding
periods. This would only occur if the same shares were the worst during two
consecutive decision periods. Furthermore, stocks in all deciles are equally
weighted.

The first 3 deciles are profitable even after TC (information ratio after TC is above 0).
Next, we only focus on the first 2 deciles, as these offer attractive return
characteristics for investors. Although information ratios for the first 2 deciles are
very attractive (6.7 and 2.0 after TC), the strategy is still very volatile, maximum
drawdowns being around 48% and 39%, respectively. Nevertheless, this is more
than compensated by annualized returns of 215% and 53%. It might be worth
exploring the short selling of the tenth decile stocks as information ratios decline
consistently from the first to the tenth decile. However, buying the first decile stocks
is profitable on its own and there might be constraints to short selling some shares in
practice. Therefore we chose not to explore this option in the paper, although it might
clearly improve the characteristics of the strategy.

The first decile is profitable not only because of higher average gains in up periods
than losses in down periods (1.74% vs. -1.16%), but also because of more frequent
up periods than down periods (1844 vs. 689). As one moves towards the tenth
decile, the number of up periods falls in such a way that the tenth decile has almost
the opposite ratio of up vs. down periods compared to the first decile. Also the

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average gain in up periods is smaller (1.13%) than the average loss in down periods
(-1.59%) for the tenth decile stocks.

Decile 1 2 3 4 5 6 7 8 9 10
Information Ratio (ex TC) 7.49 2.98 1.56 0.76 0.39 -0.13 -0.63 -1.25 -2.47 -5.69
Information Ratio (incl. TC) 6.70 2.01 0.51 -0.34 -0.74 -1.27 -1.74 -2.34 -3.47 -6.53
Cumulative Return (incl. TC) 2157% 528% 121% -78% -166% -283% -395% -546% -880% -1974%
Annualised Return (incl. TC) 215% 53% 12% -8% -17% -28% -39% -54% -88% -196%
Annualised Volatility (incl. TC) 32.0% 26.1% 23.8% 23.0% 22.5% 22.1% 22.5% 23.2% 25.2% 30.1%
Maximum Daily Profit (ex TC) 21.6% 14.5% 12.0% 10.5% 9.0% 8.2% 8.5% 8.6% 9.1% 8.2%
Maximum Daily Loss (ex TC) -13.6% -14.3% -11.8% -11.8% -9.4% -10.1% -10.6% -10.7% -11.3% -13.5%
Maximum Drawdown (ex TC) 48% 39% 52% 61% 52% 99% 182% 318% 665% 1761%
Maximum Drawdown Duration (ex TC) 54 144 280 289 315 1579 2502 2525 2530 2530
Number of Up Periods (ex TC) 1844 1551 1451 1375 1317 1283 1233 1187 1102 849
Number of Down Periods (ex TC) 689 982 1082 1158 1215 1250 1300 1346 1431 1684
Avg Return (ex TC) 0.95% 0.31% 0.15% 0.07% 0.03% -0.01% -0.06% -0.12% -0.25% -0.68%
Avg Gain in Up Periods (ex TC) 1.74% 1.21% 1.05% 0.99% 0.98% 0.95% 0.98% 1.00% 1.04% 1.13%
Avg Loss in Down Periods (ex TC) -1.16% -1.11% -1.06% -1.03% -0.99% -1.00% -1.04% -1.10% -1.24% -1.59%
Table 2. Version 1 of the strategy applied to the constituent stocks of the S&P 600 SmallCap Index.
Decision period is from today’s close to the next day’s open and holding period from the next day’s open
to the next day’s close. The results are divided into deciles. The first decile contains the worst
performing shares during the decision period, the tenth decile the best ones.

In Table 3 below we show the performance of version 2 of the strategy. Thus this
time, compared to Table 2, the decision and holding periods are swapped. The
decision period is the day and the holding period is the night. The table contains the
results of applying the strategy to the constituent stocks of the S&P 600 SmallCap
Index. Again, we divided the performance into deciles. The first decile contains the
worst performing shares during the decision period.

Decile 1 2 3 4 5 6 7 8 9 10
Information Ratio (ex TC) 5.46 2.72 1.69 0.51 -0.26 -1.06 -1.61 -2.53 -3.13 -5.03
Information Ratio (incl. TC) 4.06 0.66 -0.64 -1.94 -2.76 -3.56 -3.95 -4.69 -4.98 -6.21
Cumulative Return (incl. TC) 734% 81% -70% -201% -279% -361% -427% -550% -681% -1336%
Annualised Return (incl. TC) 73% 8% -7% -20% -28% -36% -43% -55% -68% -133%
Annualised Volatility (incl. TC) 18.0% 12.2% 10.8% 10.3% 10.1% 10.1% 10.8% 11.7% 13.6% 21.4%
Maximum Daily Profit (ex TC) 9.5% 5.2% 4.3% 4.9% 4.9% 4.6% 5.1% 5.6% 6.5% 7.7%
Maximum Daily Loss (ex TC) -7.0% -6.7% -6.6% -6.5% -7.8% -9.0% -10.5% -12.0% -14.5% -21.6%
Maximum Drawdown (ex TC) 11% 16% 24% 37% 51% 125% 190% 308% 436% 1084%
Maximum Drawdown Duration (ex TC) 44 126 296 819 1848 2525 2531 2531 2520 2531
Number of Up Periods (ex TC) 1722 1479 1427 1319 1218 1157 1117 1062 1035 931
Number of Down Periods (ex TC) 810 1053 1105 1213 1314 1374 1415 1470 1497 1601
Avg Return (ex TC) 0.39% 0.13% 0.07% 0.02% -0.01% -0.04% -0.07% -0.12% -0.17% -0.43%
Avg Gain in Up Periods (ex TC) 0.82% 0.54% 0.45% 0.40% 0.39% 0.37% 0.38% 0.39% 0.41% 0.46%
Avg Loss in Down Periods (ex TC) -0.53% -0.43% -0.42% -0.40% -0.38% -0.39% -0.42% -0.48% -0.57% -0.94%
Table 3. Version 2 of the strategy applied to the constituent stocks of the S&P 600 SmallCap Index.
Decision period is from today’s open to today’s close and holding period is from today’s close to the
next day’s open. The results are divided into deciles. The first decile contains the worst performing
shares during decision period, the tenth decile the best ones.

As shown in Table 3, the information ratios without TC in the first 4 deciles are very
attractive. However, when TC are taken into account, only the first two deciles
remain profitable. Again, there is a clear structure present in the table across deciles,
as was the case in Table 2. Profitability constantly decreases, when we move
towards the higher deciles. Information ratios (both with and without TC) for most
deciles were more attractive in Table 2 than in Table 3. Furthermore we only
compare the trading statistics of the first two deciles, as only these are suitable for
trading. The strategy presented in Table 3 is less volatile than the one presented in
Table 2, as its annualised volatility is lower for the first two deciles (18.0% and 12.2%

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vs. 32.0% and 26.1%). This is also confirmed by a smaller spread for the first 2
deciles between the maximum daily profit (9.5% and 5.2%) and maximum daily loss
(-7.0% and -6.7%) than in Table 2. Also the maximum drawdown is significantly
lower for the first two deciles in Table 3 (11% and 16%) than in Table 2 (48% and
39%). However, the edge of the second strategy variation seems to be smaller, as
the average daily return is 0.39% compared to 0.95% for the first decile stocks and
only 0.13% compared to 0.31% for the second decile stocks. However, both versions
of the strategy are profitable for the first 2 deciles when applied to the constituent
stocks of the S&P 600 SmallCap Index.

Furthermore, we describe the results for S&P 400 MidCap and S&P 500 Index,
however corresponding tables are included in Appendices b-e. In Table 11 in
Appendix b we present the results of version 1 of the strategy (same as in Table 2)
applied to the constituent stocks of the S&P 400 MidCap Index. The information
ratios without TC are lower than in Table 2 for the first five deciles. From decile 6
until 10 the information ratios are higher in Table 11. This means that the
overreaction is not as strong for mid cap stocks as it was for small caps. The stocks
that fell the most in the decision period do not subsequently rise so strongly and on
the other hand stocks that rose in the decision period do not fall as sharply as was
the case for small cap stocks. The information ratios with TC for the first 2 deciles
are 3.98 and 1.03 compared to 6.70 and 2.01 from Table 2.

In Table 12 in Appendix c we show the performance of version 2 of the contrarian

strategy applied to the constituent stocks of the S&P 400 MidCap Index. Again, its
performance is worse compared to version 1 applied to the same universe of stocks
(for comparison see Table 11). The information ratios (both with and without TC) are
higher in Table 11 than in Table 12. On the other hand, volatility is significantly lower
for version 2 of the strategy (16.6% compared to 28.5% for the first decile stocks).
This is also confirmed by a lower maximum drawdown (13% compared to 60% for
the first decile stocks). When we compare version 2 of the strategy applied to the
small (Table 3) and mid cap (Table 12) stocks, the small cap universe offers better
investment characteristics for the first 5 deciles. Thus, again as was the case for
version 1 of the strategy, the overreaction is stronger for small cap stocks than it is
for mid cap stocks.

In Table 13 in Appendix d we present the results of applying version 1 of the strategy

to the constituent stocks of the S&P 500 Index. When we focus on the first decile
results, we can see that the strategy is still profitable and although the information
ratios are worse than in the case of small and mid cap stocks, they are still attractive
for investors. The information ratios after TC for the first decile stocks for small, mid
and large cap stocks are 6.70, 3.98 and 1.85.

Finally, in Table 14 in Appendix e we present version 2 of the strategy applied to the

constituent stocks of the S&P 500 Index. The only decile that is profitable is the first
decile and that is why we will exclusively focus on it. Surprisingly and unlike in the
previous two cases (application of version 2 of the strategy to small and mid cap
stocks), version 2 of the strategy seems to offer better investment characteristics for
the big cap stocks than version 1. Information ratios (both with and without TC) are
bigger in Table 14 than in Table 13. The maximum drawdown for version 2 is only
14.0% and the annualized volatility 17.7%. Version 2 of the strategy applied to the

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large cap stocks is even more attractive than it was when applied to the mid cap
stocks (information ratio with TC of 3.24 vs. 1.59 as in Table 12).
5.2. Strategy performance by year
In Table 4 below we show the information ratios of the benchmark strategy (close-to-
close) by year. Only the most profitable stocks, the first decile stocks, are shown. It
can be seen from the table that when applied to the constituent stocks of the S&P
500 Index, the strategy did not perform well in the time period investigated. The best
performance was achieved on the constituent stocks of the S&P 600 Small Cap
Index. The information ratios achieved in the period 2000-2006 are positive,
nevertheless, from 2007 it was not consistently profitable any more. Results are
gradually worse for the S&P 400 MidCap Index and S&P 500 Index constituents.

Information Ratio (incl. TC)

Year S&P 600 SmallCap Index S&P 400 MidCap Index S&P 500 Index
2000 2.88 1.38 -0.44
2001 2.32 0.39 -0.23
2002 1.23 -0.36 -0.16
2003 2.85 1.77 0.58
2004 2.51 1.60 -0.01
2005 0.88 1.18 -0.28
2006 0.98 -0.42 -0.60
2007 -0.60 -1.05 -1.62
2008 -1.22 -0.92 -0.90
2009 0.95 1.23 1.67
2010 -4.53 -3.86 -2.87
Table 4. A breakdown of the performance of the benchmark strategy by year. The strategy is applied to
the constituent stocks of the 3 indices and information ratios reported here correspond to the first decile
stocks in each index.

In Table 5 below, the information ratios of version 1 of the strategy are shown by
year. Again we only show the result for the first decile stocks. We can see that it
achieved high information ratios during most years. The 2010 readings should be
interpreted with care, as our dataset finishes on 12 th February 2010. However, there
seems to be a general tendency of decreasing information ratios as we move
towards 2010 from 2000.

Information Ratio (incl. TC)

Year S&P 600 SmallCap Index S&P 400 MidCap Index S&P 500 Index
2000 14.59 9.85 2.72
2001 17.05 8.56 4.26
2002 14.10 4.52 2.15
2003 16.92 8.36 4.28
2004 12.32 7.55 4.09
2005 7.27 4.20 1.72
2006 3.65 3.38 1.48
2007 1.38 2.19 0.83
2008 0.83 0.61 0.06
2009 1.63 2.17 1.47
2010 -1.22 -0.31 -0.89
Table 5. A breakdown of the performance of the version 1 of the strategy by year. The strategy is applied
to the constituent stocks of the 3 indices and information ratios reported here correspond to the first
decile stocks in each index.

In Table 6 below we show the breakdown of information ratios by year for version 2
of the strategy. Although there seems to be a tendency of decreasing information

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ratios as one moves towards 2010, recent years still show quite a strong
performance.
Information Ratio (incl. TC)
Year S&P 600 SmallCap Index S&P 400 MidCap Index S&P 500 Index
2000 8.09 3.98 1.85
2001 6.83 2.64 2.67
2002 6.60 1.21 3.20
2003 6.49 2.86 5.89
2004 6.35 3.06 7.28
2005 3.07 2.54 9.35
2006 0.67 -1.18 4.72
2007 1.27 0.37 4.34
2008 0.60 -0.22 1.14
2009 2.64 1.54 3.21
2010 1.77 0.67 1.11
Table 6. A breakdown of the performance of the version 2 of the strategy by year. The strategy is applied
to the constituent stocks of the 3 indices and information ratios reported here correspond to the first
decile stocks in each index.

We conclude that although in recent years the strategy (both version 1 and 2) seems
to have lost some power, we certainly see scope to still exploit this inefficiency in the
future.
5.3. Bid-ask bounce
The results of our strategy should also be immune to an inclusion of a bid-ask
spread. According to Park (1995), the profitability of a mean reversion strategy
disappears once the average bid-ask price is used instead of a closing price. In other
words the author states that the most significant part of the close-to-close contrarian
strategy is caused by the bid-ask bounce and is not achievable in practice.

There is no reason to suppose that our strategy’s bid-ask spread should be on

average higher than the one in the close-to-close strategy (where the close-to-close
period is the decision period and the subsequent close-to-close the holding period).
Thus, if we can show that the profitability of our strategy is well in excess of the
simple contrarian strategy where the returns are calculated from close-to-close, we
have shown that our strategy is profitable even if we include the bid-ask spread.
Thus, all the excess return of our strategy compared to the close-to-close strategy
should be practically achievable in the US stock market.

In Table 7 below we show the excess returns of the two versions of our strategy over
the close-to-close strategy (benchmark strategy). The table only contains the results
for the first decile stocks and thus the most profitable ones. The results are still very
attractive, with the information ratios including TC ranging from 1.35 to 5.87. Returns
are positive and significant in all cases.

Constituent stocks of S&P 600 SmallCap S&P 400 MidCap S&P 500
Version 1 2 1 2 1 2
Information Ratio (ex TC) 5.89 3.86 3.84 2.08 2.10 4.06
Information Ratio (incl. TC) 5.87 3.23 3.74 1.35 2.00 3.40
Cumulative Return (incl. TC) 1897% 474% 1068% 192% 593% 627%
Annualised Return (incl. TC) 188% 46% 106% 19% 59% 63%
Avg Return (ex TC) 0.75% 0.18% 0.42% 0.07% 0.23% 0.25%
Table 7. The excess returns of the 1st decile stocks of various indices over the contrarian strategy when
the holding and decision period is close-to-close. Both versions of our strategies are shown. All the

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statistics have been calculated as the difference between our strategies and the close-to-close
benchmark strategy.

6. MULTI-FACTOR MODELS
Here we show how much of our strategy’s return is attributable to style factors. We
use a classical CAPM model by Sharpe (1964), see Equation (5) below, Fama and
French (1992) 3-factor model, see Equation (6) below, and an adjusted Carhart’s
[Carhart (1997)] 5 factor model, where we add the reversion as the 5th factor, see
Equation (7) below:
r s t  r f t     (r mt  r f t )   t (5)
r s t  r f t    1 (r mt  r f t )  2 SMBt  3 HMLt   t (6)
r s t  r f t    1 (r mt  r f t )  2 SMBt  3 HMLt  4 MOM t  5 REVt   t (7)

In Table 8 just below, the detailed description of the factors used in Equations (5), (6)
and (7) can be found.

Factor3 Description

r st return of a given strategy on day t

f
r t risk-free return (calculated as the one-month Treasury bill rate)

r mt market return on all NYSE, AMEQ and NASDAQ stocks (from CRSP)

t residual of the regression on day t

A Fama-French factor calculated using the 6 portfolios formed on size and book-to-
market. It is the average return of the three small portfolios minus the average return of
SMBt the three big portfolios calculated as:
1 1
SMB  (Small _ Value  Small _ Neutral  Small _ Growth)  ( Big _ Value  Big _ Neutral  Big _ Growth) (8)
3 3
A Fama-French factor calculated as the average of the two value portfolios minus the
average of the two growth portfolios:
HMLt 1 1
HML  ( Small _ Value  Big _ Value)  ( Small _ Growth  Big _ Growth) (9)
2 2
A Fama-French obtained from 4 portfolios formed at the beginning of every month M.
The portfolios are based on the size and previous (M-2 to M-12) months total return.
Thus, all the shares have been divided into 1 of the 4 groups: small cap high return, big
cap high return, small cap low return and big cap low return. The prior month return (M-1)
MOM t
is excluded from the calculation due to a well known reversion in momentum portfolios.
1 1
MOM  ( Small _ HighRET  Big _ HighRET )  ( Small _ LowRET  Big _ LowRET ) (10)
2 2

A short term reversion Fama-French factor constructed using 4 portfolios which are
formed based on size and prior 1 month returns. The REVt factor is calculated as
REVt follows:
1 1
REV  ( Small _ LowRET  Big _ LowRET )  ( Small _ HighRET  Big _ HighRET ) (11)
2 2
Table 8. Description of the factors used in Equations (5), (6) and (7).

3
Market return, risk-free rate and all the subsequent factors (HML, SMB, MOM and REV) used in this
section have been downloaded from the website:
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. (Accessed on 3rd May
2010). All the factors are calculated daily based on monthly rebalanced portfolios.

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In Table 9 below we present the results of applying the regressions based on the
models described just above to version 1 of the strategy on the constituent stocks of
the S&P 600 SmallCap Index. The regressions were only applied to the first decile
stocks in all cases analysed in this section. The explanatory power of all the models
is quite high (0.45 for CAPM and 0.60 for both 3- and 5-factor models). All the
models estimate similar and significant alpha of around 0.76%. This shows that
version 1 of our strategy indeed adds value. Also note that Carhart’s regression
properly identifies our strategy as a contrarian one, where β 4 (the momentum factor)
is a negative -0.12 and β5 (the reversion factor) is a positive 0.07.
α β1 β2 β3 β4 β5
CAPM
coefficient 0.0079 0.88
t-stat 29.42 44.83
p-value 0.00 0.00
R-squared 0.45
Fama-French 3 factor model
coefficient 0.0076 0.87 1.13 0.35
t-stat 32.75 52.11 28.98 10.36
p-value 0.00 0.00 0.00 0.00
R-squared 0.60
Carhart + Reversion
coefficient 0.0076 0.80 1.15 0.33 -0.12 0.07
t-stat 32.74 39.17 29.48 9.49 -5.31 2.83
p-value 0.00 0.00 0.00 0.00 0.00 0.00
R-squared 0.60
Table 9. 3 different factor models applied to the returns generated by the version 1 of the strategy applied
to the constituent stocks of the S&P 600 SmallCap Index. The regressions were only applied to the first
decile stocks.

In Table 10 below we present the results of applying the regression models to

version 2 of the strategy to the constituents stocks of the S&P 600 SmallCap Index.
The explanatory power of all the models is very similar (R-squared of 0.19 for all of
them) and lower than in case of version 1 (Table 9). All the models estimate similar
and significant alpha of around 0.2%. Although the estimated alpha is smaller than
the one obtained with version 1, it is still positive and significant. Thus, both versions
of the strategy seem to add value when applied to the constituent stocks of the S&P
600 SmallCap Index and there is a significant alpha which cannot be explained by
market factors.

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 α β1 β2 β3 β4 β5
CAPM
coefficient 0.002 0.26
t-stat 15.90 23.95
p-value 0.00 0.00
R-squared 0.19
Fama-French 3 factor model
coefficient 0.002 0.26 -0.03 0.07
t-stat 15.80 23.98 -1.07 3.16
p-value 0.00 0.00 0.28 0.00
R-squared 0.19
Carhart + Reversion
coefficient 0.002 0.24 -0.02 0.07 -0.02 0.03
t-stat 15.60 18.13 -0.86 3.14 -1.40 2.09
p-value 0.00 0.00 0.39 0.00 0.15 0.03
R-squared 0.19
Table 10. 3 different factor models applied to the returns generated by the version 2 of the strategy
applied to the constituent stocks of the S&P 600 SmallCap Index. The regressions were only applied to
the first decile stocks.

We also analyse the strategy results (both version 1 and 2) when applied to the
constituent stocks of the S&P 400 MidCap and S&P 500 Indices. The results can be
found in the Appendices f-i. Here we summarize that for all the shares in question
and both versions of the strategy, alpha is significant and positive. Alphas generated
by versions 1 and 2 of the strategy when applied to the constituent stocks of the S&P
400 MidCap Index are 0.4% and 0.1%, respectively. Alphas of the 2 versions when
applied to the constituent stocks of the S&P 500 Index are both 0.2%. This further
confirms that both versions of our strategy add value as they extract a significant
alpha which cannot be explained by market factors.

7. CONCLUDING REMARKS
In this article we show two modified versions as an alternative to a well-known
contrarian strategy of buying losers and selling winners. Both versions only buy
shares and no short selling is required. N worst performing shares during the day
(resp. the night) are bought and held during the subsequent night (resp. day) in
equal proportion. We investigate the behaviour of these 2 simple versions of the
strategy from 30th May 2000 until 12th February 2010 on the constituent stocks of the
S&P 500, S&P 400 MidCap and S&P 600 SmallCap Index.

The 2 versions of the strategy are more profitable than its well-known version (close-
to-close as decision and holding periods). Their returns cannot be solely explained
by the factors from either the 3-factor model of Fama and French (1993) or a
modified 5-factor version of the model of Carhart (1997). Both versions of the
proposed strategy prove profitable even in the recent period and are able to create a
significantly positive alpha. The information ratios after the inclusion of TC over an
entire sample period range from 1.59 to 6.70 depending on the universe of the
stocks in question. We also show that the results are immune to the consideration of
the bid-ask spread and that opening prices contain information that is not fully
utilized yet. Overall, the strategy proposed uses this information to add value and
extract a significant alpha which cannot be explained by market factors.

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APENDICES:
a. Calculation of the trading statistics

1 N
Annualised Return R A  252 *  Rt
N t 1
with Rt being the daily return

*  Rt  R 
N
Annualised 1
 A  252 *
2
Volatility N  1 t 1
RA
IR 
Information Ratio A

Maximum negative value of  R  over the period

t

Maximum  t 
MD  Min  Rj 
i 1,,t ;t 1,, N  
Drawdown
 j i 

b. Application of version 1 of the strategy to constituents of the S&P 400 Mid

Cap

Decile 1 2 3 4 5 6 7 8 9 10
Information Ratio (ex TC) 4.86 2.10 1.47 0.70 0.36 -0.10 -0.41 -0.65 -1.41 -2.76
Information Ratio (incl. TC) 3.98 1.03 0.31 -0.50 -0.88 -1.34 -1.65 -1.85 -2.50 -3.66
Cumulative Return (incl. TC) 1141% 245% 68% -105% -180% -274% -338% -390% -581% -1034%
Annualised Return (incl. TC) 114% 24% 7% -10% -18% -27% -34% -39% -58% -103%
Annualised Volatility (incl. TC) 28.5% 23.6% 21.8% 20.9% 20.2% 20.3% 20.4% 21.0% 23.2% 28.1%
Maximum Daily Profit (ex TC) 18.0% 12.7% 10.8% 9.2% 8.1% 7.5% 8.0% 7.6% 8.8% 9.3%
Maximum Daily Loss (ex TC) -11.6% -10.8% -10.7% -9.1% -10.6% -9.8% -9.7% -8.7% -11.1% -11.5%
Maximum Drawdown (ex TC) 60% 60% 45% 49% 44% 90% 144% 189% 381% 821%
Maximum Drawdown Duration (ex TC) 72 140 164 413 698 2047 2278 2381 2501 2530
Number of Up Periods (ex TC) 1701 1502 1469 1376 1340 1310 1271 1245 1167 1132
Number of Down Periods (ex TC) 832 1031 1064 1157 1193 1223 1262 1288 1366 1401
Avg Return (ex TC) 0.55% 0.20% 0.13% 0.06% 0.03% -0.01% -0.03% -0.05% -0.13% -0.31%
Avg Gain in Up Periods (ex TC) 1.37% 1.02% 0.92% 0.88% 0.86% 0.84% 0.85% 0.89% 0.97% 1.07%
Avg Loss in Down Periods (ex TC) -1.12% -1.01% -0.97% -0.92% -0.90% -0.92% -0.92% -0.97% -1.07% -1.42%
Table 11. Version 1 of the strategy applied to the constituent stocks of the S&P 400 MidCap Index.
Decision period is from today’s close to the next day’s open and holding period from the next day’s open
to the next day’s close. The results are divided into deciles. The first decile contains the worst
performing shares during the decision period, the tenth decile the best ones.

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 c. Application of version 2 of the strategy to constituents of the S&P 400 Mid
Cap

Decile 1 2 3 4 5 6 7 8 9 10
Information Ratio (ex TC) 3.10 1.66 0.74 0.26 -0.28 -1.02 -1.44 -1.97 -2.53 -3.00
Information Ratio (incl. TC) 1.59 -0.48 -1.63 -2.20 -2.85 -3.55 -3.87 -4.25 -4.51 -4.40
Cumulative Return (incl. TC) 265% -57% -174% -227% -281% -355% -404% -473% -576% -798%
Annualised Return (incl. TC) 26% -6% -17% -23% -28% -35% -40% -47% -57% -79%
Annualised Volatility (incl. TC) 16.6% 11.8% 10.6% 10.3% 9.8% 10.0% 10.4% 11.1% 12.7% 18.0%
Maximum Daily Profit (ex TC) 8.4% 5.0% 5.0% 7.4% 6.6% 5.9% 7.0% 5.1% 7.4% 7.8%
Maximum Daily Loss (ex TC) -7.5% -7.7% -7.0% -6.8% -7.2% -8.1% -9.2% -10.8% -12.7% -18.0%
Maximum Drawdown (ex TC) 13% 26% 39% 42% 52% 112% 157% 222% 327% 550%
Maximum Drawdown Duration (ex TC) 83 304 554 836 1265 2525 2513 2526 2531 2531
Number of Up Periods (ex TC) 1547 1433 1389 1323 1274 1232 1184 1108 1111 1103
Number of Down Periods (ex TC) 985 1099 1143 1209 1258 1300 1348 1424 1421 1429
Avg Return (ex TC) 0.20% 0.08% 0.03% 0.01% -0.01% -0.04% -0.06% -0.09% -0.13% -0.22%
Avg Gain in Up Periods (ex TC) 0.71% 0.48% 0.40% 0.38% 0.35% 0.33% 0.33% 0.36% 0.38% 0.48%
Avg Loss in Down Periods (ex TC) -0.59% -0.44% -0.42% -0.39% -0.37% -0.39% -0.41% -0.44% -0.52% -0.75%
Table 12. Version 2 of the strategy applied to the constituent stocks of the S&P 400 MidCap Index.
Decision period is from today’s open to today’s close and holding period is from today’s close to the
next day’s open. The results are divided into deciles. The first decile contains the worst performing
shares during the decision period, the tenth decile the best ones.

d. Application of version 1 of the strategy to constituents of the S&P 500 Index

Decile 1 2 3 4 5 6 7 8 9 10
Information Ratio (ex TC) 2.71 1.88 1.35 0.83 0.43 -0.08 -0.55 -0.92 -1.24 -3.69
Information Ratio (incl. TC) 1.85 0.76 0.10 -0.51 -0.94 -1.47 -1.93 -2.23 -2.42 -4.63
Cumulative Return (incl. TC) 544% 170% 19% -96% -173% -268% -355% -432% -521% -1243%
Annualised Return (incl. TC) 54% 17% 2% -10% -17% -27% -35% -43% -52% -124%
Annualised Volatility (incl. TC) 29.3% 22.3% 20.0% 18.8% 18.4% 18.1% 18.3% 19.3% 21.4% 26.7%
Maximum Daily Profit (ex TC) 15.5% 11.1% 9.0% 7.8% 8.4% 7.5% 7.3% 7.8% 8.4% 7.6%
Maximum Daily Loss (ex TC) -13.7% -10.1% -8.7% -8.4% -7.5% -8.0% -8.8% -8.9% -13.9% -15.3%
Maximum Drawdown (ex TC) 60% 55% 44% 43% 48% 89% 150% 213% 299% 997%
Maximum Drawdown Duration (ex TC) 78 231 150 204 491 2047 2381 2530 2530 2530
Number of Up Periods (ex TC) 1546 1482 1463 1390 1361 1294 1254 1242 1222 998
Number of Down Periods (ex TC) 987 1051 1070 1143 1172 1239 1279 1291 1311 1535
Avg Return (ex TC) 0.31% 0.17% 0.11% 0.06% 0.03% -0.01% -0.04% -0.07% -0.11% -0.39%
Avg Gain in Up Periods (ex TC) 1.24% 0.94% 0.82% 0.78% 0.76% 0.75% 0.76% 0.77% 0.84% 1.00%
Avg Loss in Down Periods (ex TC) -1.14% -0.92% -0.87% -0.81% -0.81% -0.80% -0.82% -0.88% -0.99% -1.29% T
able 13. Version 1 of the strategy applied to the constituent stocks of the S&P 500 Index. Decision period
is from today’s close to the next day’s open and holding period from the next day’s open to the next
day’s close. The results are divided into deciles. The first decile contains the worst performing shares
during the decision period, the tenth decile the best ones.

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 e. Application of version 2 of the strategy to constituents of the S&P 500 Index

Decile 1 2 3 4 5 6 7 8 9 10
Information Ratio (ex TC) 4.67 1.25 0.64 0.10 -0.31 -0.56 -1.02 -1.25 -1.57 -1.73
Information Ratio (incl. TC) 3.24 -0.79 -1.67 -2.38 -2.80 -3.03 -3.43 -3.46 -3.48 -3.05
Cumulative Return (incl. TC) 577% -98% -183% -243% -285% -311% -360% -397% -461% -585%
Annualised Return (incl. TC) 57% -10% -18% -24% -28% -31% -36% -39% -46% -58%
Annualised Volatility (incl. TC) 17.7% 12.3% 10.9% 10.2% 10.2% 10.2% 10.5% 11.4% 13.2% 19.1%
Maximum Daily Profit (ex TC) 7.6% 4.7% 4.1% 4.3% 4.9% 5.5% 5.1% 5.5% 8.0% 10.1%
Maximum Daily Loss (ex TC) -9.3% -7.4% -7.3% -7.1% -6.4% -7.1% -7.8% -9.0% -11.1% -15.5%
Maximum Drawdown (ex TC) 14% 28% 38% 49% 51% 68% 119% 149% 214% 338%
Maximum Drawdown Duration (ex TC) 52 464 540 1083 1917 2513 2513 2531 2519 2515
Number of Up Periods (ex TC) 1798 1426 1389 1334 1293 1291 1235 1238 1211 1218
Number of Down Periods (ex TC) 734 1106 1143 1198 1239 1241 1297 1294 1321 1314
Avg Return (ex TC) 0.33% 0.06% 0.03% 0.00% -0.01% -0.02% -0.04% -0.06% -0.08% -0.13%
Avg Gain in Up Periods (ex TC) 0.75% 0.49% 0.42% 0.38% 0.37% 0.36% 0.36% 0.38% 0.42% 0.57%
Avg Loss in Down Periods (ex TC) -0.70% -0.49% -0.44% -0.42% -0.41% -0.42% -0.43% -0.48% -0.54% -0.78%
Table 14. Version 2 of the strategy applied to the constituent stocks of the S&P 400 MidCap Index.
Decision period is from today’s open to today’s close and holding period is from today’s close to the
next day’s open. The results are divided into deciles. The first decile contains the worst performing
shares during the decision period, the tenth decile the best ones.

f. 3 different factor models applied to the returns generated by the version 1 of

the strategy applied to the constituent stocks of the S&P 400 MidCap Index.
The regressions were only applied to the first decile stocks

α β1 β2 β3 β4 β5
CAPM
coefficient 0.004 0.88
t-stat 18.48 52.51
p-value 0.00 0.00
R-squared 0.53
Fama-French 3 factor model
coefficient 0.0040 0.87 0.75 0.26
t-stat 19.03 57.28 21.13 8.65
p-value 0.00 0.00 0.00 0.00
R-squared 0.61
Carhart + Reversion
coefficient 0.0040 0.81 0.76 0.23 -0.14 0.02
t-stat 19.18 43.57 21.52 7.23 -6.53 0.80
p-value 0.00 0.00 0.00 0.00 0.00 0.42
R-squared 0.61

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g. 3 different factor models applied to the returns generated by the version 2 of
the strategy applied to the constituent stocks of the S&P 400 MidCap Index.
The regressions were only applied to the first decile stocks

α β1 β2 β3 β4 β5
CAPM
coefficient 0.001 0.30
t-stat 5.94 27.38
p-value 0.00 0.00
R-squared 0.24
Fama-French 3 factor model
coefficient 0.001 0.30 -0.09 0.07
t-stat 5.93 27.48 -3.39 2.99
p-value 0.00 0.00 0.00 0.00
R-squared 0.24
Carhart + Reversion
coefficient 0.001 0.30 -0.08 0.07 -0.01 0.02
t-stat 5.81 21.75 -3.27 3.06 -0.32 1.33
p-value 0.00 0.00 0.00 0.00 0.75 0.18
R-squared 0.24

h. 3 different factor models applied to the returns generated by the version 1 of

the strategy applied to the constituent stocks of the S&P 500 Index. The
regressions were only applied to the first decile stocks

α β1 β2 β3 β4 β5
CAPM
coefficient 0.002 0.93
t-stat 8.26 54.23
p-value 0.00 0.00
R-squared 0.55
Fama-French 3 factor model
coefficient 0.0018 0.93 0.34 0.23
t-stat 7.79 55.32 8.63 7.06
p-value 0.00 0.00 0.00 0.00
R-squared 0.57
Carhart + Reversion
coefficient 0.0018 0.87 0.34 0.19 -0.13 -0.01
t-stat 7.97 42.78 8.80 5.60 -5.61 -0.62
p-value 0.00 0.00 0.00 0.00 0.00 0.54
R-squared 0.57

19

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i. 3 different factor models applied to the returns generated by the version 2 of
the strategy applied to the constituent stocks of the S&P 500 Index. The
regressions were only applied to the first decile stocks

α β1 β2 β3 β4 β5
CAPM
coefficient 0.002 0.36
t-stat 13.05 28.21
p-value 0.00 0.00
R-squared 0.25
Fama-French 3 factor model
coefficient 0.002 0.36 -0.14 0.06
t-stat 13.15 28.36 -4.61 2.33
p-value 0.00 0.00 0.00 0.02
R-squared 0.26
Carhart + Reversion
coefficient 0.002 0.34 -0.13 0.07 -0.02 0.06
t-stat 12.88 21.54 -4.32 2.69 -0.89 3.39
p-value 0.00 0.00 0.00 0.01 0.37 0.00
R-squared 0.26

20

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