2010-01: Enhancing Contrarian Strategies: Evidence from Developed Markets Indices (Working paper)

Abstract

A problem for contrarian strategies is that short-term continuation can offset long-term return reversal. This paper introduces a method for enhancing contrarian strategies to avoid this problem and applies it to 18 developed markets equity indices. Using recent short-term performance to determine which contrarian indices appear ready to reverse and which do not, we define late stage and early stage contrarian strategies. Late stage strategies are consistently more profitable than both pure contrarian and early stage contrarian strategies. Our subsample results confirm a general weakening in contrarian strategy profitability post-December 1989.