ELSINER

Journal

of Financial

Economics

38 (1995)

ECONOMICS

79-107

Problems in measuring portfolio performance

An application to contrarian investment strategies
Ray Ball, S.P. Kothari,
William

Jay Shanken

E. Simon Graduate

School of Business Administration,

Rochester, NY 14627, USA

(Received

1992; final version

September

received

University

of Rochester,

July 1994)

Abstract

We document problems in measuring raw and abnormal five-year contrarian portfolio returns. Loser stocks are low-priced
and exhibit skewed return distributions.
Their 163% mean return is due largely to their lowest-price quartile position. A %ith
price increase reduces the mean by 25%, highlighting
their sensitivity to microstructure/liquidity
effects. Long positions in low-priced
loser stocks occur disproportionately
after bear markets and thus induce expected-return
effects. A contrarian
portfolio formed at June-end earns negative abnormal returns, in contrast with the
December-end
portfolio. This conclusion is not limited to a particular version of the
CAPM.
Key words: Contrarian
efficiency; Asset pricing
JEL classilfcation: Gil;

*Corresponding

strategy;

Low-priced

stocks; Portfolio

performance;

Market

G12; G14

author.

We thank Sudipta Basu and Richard

Sloan for excellent research assistance. We are grateful for
the comments
of John Long, Jay Ritter, Bill Schwert (the editor), Jerry Zimmerman,
two anonymous referees, and seminar participants
at Boston University,
University
of Illinois, University
of Iowa,
University of Rochester,
Vanderbilt
University,
the Stanford
Summer
Camp, the
Cornell-Rochester
joint workshop,
the 1992 Conference
on Financial
Economics
and Accounting at New York University,
and the City University
Business School in London. We acknowledge
financial
support
from the Bradley
Policy Research
Center at the Simon School, University
of Rochester,
from the John M. Olin Foundation,
and from the Institute for Quantitative
Research
in Finance.
0304-405X/95/$09.50

SSDI 0304405X9400806

1995 Elsevier

Science S.A. All rights

reserved

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1. Introduction

We study problems in measuring the performance of contrarian portfolios,

similar to those examined by DeBondt and Thaler (1985, 1987), Chan (1988),
Ball and Kothari (1989), Chopra, Lakonishok, and Ritter (1992), and Jones
(1993), among others. Measurement problems are apparent in both raw and
abnormal five-year buy-and-hold returns. The problems are unusually severe for
contrarian portfolios because they invest in extremely low-priced loser stocks.
Still, many of the issues we raise should be relevant to performance measurement in general.
The possibility that microstructure factors systematically bias measured raw
returns has received little attention in the context of portfolio performance
measurement (Conrad and Kaul, 1993, is an exception). By being short in
comparatively high-priced winner stocks and long in comparatively low-priced
loser stocks, contrarian portfolios have an unhedged position in price-related
microstructure-induced
biases. Loser stocks are on average so low-priced that
just a $i increase in their purchase price reduces their average five-year buyand-hold return by 25% (2500 basis points). The corresponding reduction for
the lowest-price quartile of loser stocks is an enormous 86%. The surprisingly
large effect of a $$ price adjustment highlights the sensitivity of measured returns
on these portfolios to microstructure effects (spreads, liquidity, and brokerage
costs), or to even a small amount of security mispricing.
We report a variety of evidence that microstructure-induced
biases can be
acute, even in five-year returns. For example, loser-stock return distributions
are highly right-skewed. The 163% mean loser-stock five-year return is due
largely to the lowest-price quartile of losers, whose mean return is 357%. The
average price of these stocks is only $1.04. To make things worse, the effects of
long positions in low-priced loser stocks occur disproportionately
after bear
markets and thus are compounded by expected-return effects, as observed by
Jones (1993).
We also investigate June-end investment periods. A body of evidence (Roll,
1983a; Lakonishok and Smidt, 1984; Keim, 1989; Bhardwaj and Brooks, 1992)
suggests that microstructure-related
biases in measured returns are most
pronounced at the calendar year-end, which is precisely when contrarian portfolios typically are formed (see studies by DeBondt and Thaler, Chan, Ball and
Kothari, and Chopra et al. previously cited). In addition, Zarowin (1990) shows
that size, January, and contrarian effects are not independent. We report that
the average five-year loser-stock return is 3 1O/olower for June-end than December-end periods, even though they share 53.5 of their 54 years in common. For
the lowest-priced quartile of loser stocks, the December-June difference averages 103%. Similar results are obtained for August-end periods. The sensitivity
of the DeBondt and Thaler portfolios average return to an arbitrary starting
point in calendar time suggests performance measurement problems and casts

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81

doubt on the evidence that has been presented for the contrarian hypothesis. As
DeBondt and Thaler (1985, p. 799) themselves note, their choice of December-end as the portfolio formation date is essentially arbitrary.
The above problems relate to measuring contrarian portfolio raw returns.
We also highlight problems in performing a risk-adjusted abnormal-return
analysis. We employ Kothari and Shankens (1992) version of the excess-return
time-series regression methodology (see Chan, 1988; Ball and Kothari, 1989) to
estimate Jensen alphas, while allowing conditional betas to vary over time.
Because the contrarian strategy by definition selects stocks that have behaved
and are expected to behave contrary to the index, it is appropriate to control for
the index effects in its evaluation. Therefore, unlike raw returns, Jensen alphas
are still expected to be zero in spite of the disproportionate
incidence of
low-price loser stocks after bear markets. The June-end contrarian portfolio has
a negative 2.5% alpha over the five-year post-formation period, compared with
a positive 4.3% for the December-end portfolio. It earns negative abnormal
returns in four of its five post-formation years when constructed at the end of
June, but it appears profitable in all five years if constructed at the end of
December. We argue that the June-end (or August-end) results are more reliable.
Regardless of its source, the sensitivity of the abnormal return estimates to
choosing a seemingly-arbitrary interval end point casts doubt on the robustness
of the DeBondt and Thaler (1985, 1987) results.
Chopra et al. argue that the empirical relation between estimated betas and
average returns is flatter than implied by the Sharpe-Lintner model, and that
Jensen alphas underestimate the contrarian strategys profitability as a consequence. This argument is made more pointed by the conclusion of Fama and
French (1992, p. 464) that . . the relation between j and average return for
1941-1990 is weak, perhaps nonexistent and thus the model . . . does not
describe the last 50 years of average stock returns. While the risk-return
tradeoff may indeed be flatter than implied by the Sharpe-Lintner model, we
argue that beta still plays an important role in risk adjustment (see Kothari,
Shanken, and Sloan, 1994; Jagannathan and Wang, 1993). In any event, the
June-end contrarian portfolio is not profitable even if the risk-return slope is
considerably flatter than the risk premium implied by the Sharpe-Lintner
model. An annual risk premium of 9% and zero-beta rate 5% above T-bill rates
(i.e., the risk premium and zero-beta rate estimates of Chopra et al.) would lead
to an average abnormal return of only 1.4% for the June-end strategy, merely
0.35 standard errors from zero. We conclude that the lack of evidence of
contrarian profitability for the June-end strategy is not limited to a particular
version of the capital asset pricing model (CAPM).
Although the mean-variance framework has been the main approach to
performance evaluation in the literature, we point to several features of the
data that suggest this framework may not be completely satisfactory. First,
it is important to appreciate that incorporating the well-known size, price,

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book-to-market,
and liquidity-related
deviations from the security market line
(e.g., Banz, 1981; Fama and French, 1992; Amihud and Mendelson, 1986) would
only serve to increase the (normal) required return for the losers relative to that
for the winners. In this sense, abnormal contrarian returns based on the
mean-variance framework may well be biased upward.
Second, we also briefly examine the contrarian portfolios beta behavior
in up and down markets. DeBondt and Thaler (1987) and Chopra et al. observe
that the contrarian portfolio has a considerably higher up-market than downmarket beta. We show that this beta behavior is accompanied by a large
negative alpha, which diminishes the appeal of the relatively high up-market
beta.
Third, the distribution of loser-stock returns is highly right-skewed, such that
the difference between median returns on winner and loser stocks is less than
one-sixth of the difference between their means. This suggests caution when
focusing solely on mean returns of contrarian portfolios, and perhaps also when
using beta-adjusted returns.
We caution that our initial sample includes both New York and American
Stock Exchange (NYSE-AMEX)
stocks. Hence, as a robustness check and to
provide better comparability with prior research, we briefly summarize results
for an NYSE-only sample. We are able to report that all the results are
essentially unchanged by the exclusion of AMEX stocks.
Section 2 describes the data and procedures for constructing contrarian
portfolios. Section 3 examines the effects on contrarian raw returns of price and
choice of year-end. Section 4 examines abnormal returns for both Decemberand June-end contrarian portfolios, by estimating excess-return time-series
regressions. Section 5 contains concluding remarks.

2. Data and procedures for constructing

contrarian

portfolios

Each year we rank all NYSE-AMEX

stocks on the Center for Research in
Security Prices (CRSP) monthly tapes on the basis of their buy-and-hold returns
over the preceding five years, denoted as the ranking period. The fifty stocks
ranked lowest and highest each year are labeled losers and winners. These
loser and winner stocks performances are monitored over a five-year postranking period. Ranking periods ending in both December and June are
considered. Data are available from December 31, 1925 for NYSE stocks and
from June 30, 1962 for AMEX stocks. The first post-ranking period begins in
1931 and the last in 1984. Thus, there are 54 overlapping ranking and postranking periods, denoted as event years - 4 through + 5. We examine both
five-year and annual buy-and-hold post-ranking returns.
To provide a more powerful test of the contrarian hypothesis, the contrarian
portfolios we simulate differ in two ways from those in previous studies. First, we

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83

study both NYSE and AMEX stocks, whereas DeBondt and Thaler, Ball
and Kothari, and Chopra et al. study only NYSE stocks. NYSE stocks
have higher average capitalization
and price, and are followed by more
analysts. Evidence in Chopra et al. suggests that small-capitalization
stocks
are more likely to experience overreaction. Thus, including AMEX stocks
would make both contrarian and microstructure effects more pronounced
and thus more observable. As a robustness check, and for better comparability
with prior research, Section 4.3 summarizes results for a NYSE-only sample,
which are similar. Second, the winner and loser portfolios consist of 50 stocks,
as in some of the DeBondt and Thaler (1985, 1987) analysis and in Ball and
Kothari, but different from the vitile portfolios in much of the Chopra et al.
analysis.
As in DeBondt and Thaler (1985, 1987) and Chopra et al., firms delisted
during the post-ranking period are included. Fifteen percent of the loser stocks
are delisted for financial-distress-related
reasons, compared to less than 2% of
the winner stocks. The delisting frequency due to mergers and takeovers is about
7% for both winner and loser stocks. Inclusion of returns up to the delisting
date, as in Chopra et al., mitigates the bias in favor of the contrarian hypothesis,
but ignores the considerable losses on some of these stocks between the delisting
date and their liquidating dividend payment date. For the subset for which data
are available on the CRSP tape (about 30% of all the delisted stocks),
the liquidating
dividend represents an additional 15% average loss. If the
final return or liquidating dividend is not reported on the CRSP tape, unlike
DeBondt and Thaler (1985, 1987), we do not assume a negative 100% return.
We only include returns available on the CRSP tapes. Because of the greater
delisting frequency of losers, this procedure imparts a slight upward bias to the
contrarian portfolio return. An informal analysis finds the earnings performance
over the post-ranking period of the delisted stocks, whose liquidating dividend is
unavailable, to be overwhelmingly poor. Note that CRSP generally correctly
reports the final return on stocks delisted due to takeovers and mergers. We
investigate two alternatives: 1) Include the liquidating dividend (i.e., include
a post-delisting return that on average is negative) and assume the market
return was earned on that dividend from the delisting month to the end of the
post-ranking period; or 2) ignore both. The results are similar, and we report the
latter.

3. Contrarian

portfolio

raw returns

This section reports the effect on raw returns of choosing June versus December ending periods and of the level of stock price (as a proxy for microstructure
effects such as spreads, liquidity, and other transaction costs). Analysis of
abnormal returns appears in Section 4.

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Table 1
Loser and winner stocks market capitalization and stock prices: December- and June-end samples
Descriptive statistics for market capitalization and stock prices at the end of the five-year ranking
period ending on December 31 and June 30. Samples consist of 50 worst-performance and
best-performance stocks each year from among all the NYSE and AMEX stocks that have returns
available continuously over the preceding five years (the ranking period). The worst- and bestperformance stocks are identified by ranking all available stocks on buy-and-hold raw returns over
the five-year ranking period. There are 54 overlapping five-year ranking periods ending in December
1930 to December 1983 or June 1931 to June 1984, resulting in a total of 2700 firm-period
observations in each sample. The first and second periods split the entire period in the middle.
Price
Period

Mean

Market capitalization
S.D.

SD.

Min.

599.9
140.8
845.6

0.0
0.0
0.3

8.8
4.6
15.5

26708
3530
26708

44.9
25.0
65.2

178.1
136.2
211.6

0.0
0.0
0.3

8.0
3.9
14.5

4944
3530
4944

34.19
32.25
36.19

650.0 295.3
650.0 105.7
593.0 488.9

821.3
297.8
1095.7

0.1
0.1
4.0

74.7
27.3
177.3

15958
6498
15958

35.88
33.53
37.50

737.5 289.8
737.5 87.0
545.0 496.1

803.1
189.0
1086.6

0.5
0.5
4.0

73.2
26.9
177.5

15958
3611
15958

Min.

Med.

0.06
0.06
0.19

5.00
5.00
4.89

0.13
0.13
0.25

5.38
5.25
5.50

43.37
45.51
41.08

0.50
0.50
2.63

43.10
45.02
41.05

0.88
0.88
2.13

Max.

Mean

Med.

Max.

Panel A: December/losers

Entire
First
Second
Panel B:

Entire
First
Second

10.49
11.07
9.90

28.25
20.48
34.28

1100
67.1
247.5 21.1
1100
109.3

June/losers
10.30
11.77
8.83

16.61
21.19
9.98

215.5
215.5
131.4

Panel C: December/winners

Entire
First
Second

43.47
41.97
44.98

Panel D: June/winners

Entire
First
Second

44.61
43.32
45.89

Price is in dollars; market capitalization is in millions of dollars at the end of the ranking period.
Standard deviation.

3.1. Winner and loser stocksprices and returns

3.1.1. Prices and capitalization of contrarian stocks

Table 1 provides descriptive statistics on stock price and market capitalization at the end of the ranking period. Each sample is 2700 firm-period observations (50 firms x 54 periods of five years each). Statistics also are reported for
the first 27 and last 27 five-year subperiods. We focus initially on panels A and
C, which assume December-end periods, for comparison with prior studies.

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85

The loser-stock price distribution is right-skewed. The $10.49 mean price is

more than double the $5 median. The $0.06 minimum price is for six stocks that
bunch in two adjacent year ends, 1939 and 1940. In contrast, winner-stock mean
(median) prices are approximately four (seven) times loser-prices. We emphasize three implications.
First, the typically low prices and small market capitalizations of loser stocks
question the implementability
of the DeBondt and Thaler (1985, 1987) research
design, which assumes that positions can be established at CRSP closing prices
and thus ignores bid-ask spreads, illiquidity,
and other transaction costs.
Expressed in percentage terms (for comparison with rates of return), bid-ask
spreads and transactions costs are large for these stocks. It could be difficult to
invest any substantial amount in most of these stocks without influencing the
price. (Although we expect greater liquidity in the higher-priced winner stocks,
whether an economically meaningful number of their shares can be sold short to
implement the DeBondt and Thaler strategy is also unclear.)
Second, the price difference between winners and losers implies that price is
not controlled for in simulated contrarian portfolios, which are short on winners
and long on losers. These portfolios are thus unhedged with respect to pricerelated microstructure effects (spreads, illiquidity, and other transaction costs).
Third, the low market capitalization of the loser stocks suggests that prior
research on contrarian strategies is unlikely to be of great interest to the
investment community in any event.
3.1.2. December-end

mean and median returns

In Table 2, panels A and C report December-end raw returns over the

five-year post-ranking period. The mean returns on the loser and winner
portfolios differ by 91% (163% and 72%, respectively). The result holds in both
subperiods (rows 2 and 3), even though the first subperiod has higher volatility
and higher average return (196% versus 130% for losers). (The higher average
returns of both loser and winner stocks over the first subperiod is due, in part, to
market-wide factors. The average annual return on the CRSP equal-weighted
market portfolio is 18.9%, as compared to 15.6% over the second subperiod.)
Taken uncritically, the difference in mean returns between loser and winner
stocks supports the contrarian theory.
The distributions of five-year buy-and-hold returns are right-skewed, with
minimum
- 99% and maximum
+ 5936% among losers. In a sample of size
2700, the maximum observation alone adds 2.2% to the mean. Median returns for
both winners and losers are substantially lower than their means. Moreover, the
The median capitalization
of the losers is only $8.8 million. (The average of $67 million is influenced
by a $26 billion outlier.) Table 1 suggests the price distribution
is more stationary
than market
capitalization,
presumably
due to stock splitting, so in time-series or pooled research designs price is
less likely to proxy for time. It nevertheless
has a cyclical component.

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Table 2
Loser and winner stocks post-ranking period returns: December- and June-end samples
Descriptive statistics for five-year buy-and-hold post-ranking period returns and returns adjusted
for a $i transaction cost. Ranking periods ending on December 31 and June 30. Samples consist of
50 worst-performance and best-performance stocks each year from among all the NYSE and AMEX
stocks that have returns available continuously over the preceding five years (the ranking period).
The worst- and best-performance stocks are identified by ranking all available stocks on buy-andhold raw returns over the five-year ranking period. There are 54 overlapping five-year ranking
periods ending in December 1930 to December 1983 or June 1931 to June 1984, resulting in a total of
2700 firm-period observations in each sample. The first and second periods split the entire period in
the middle.
5-year return
Period

Mean

S.D.

5-year adj. return

Min.

Med.

Max.

Mean

S.D.

Min.

Med.

Max.

4.27
4.85
3.56

-0.99
-0.99
-0.98

0.49
0.61
0.40

59.36
55.32
59.36

1.38
1.59
1.17

3.51
3.75
3.25

- 1.00
-1.00
-0.98

0.44
0.54
0.35

55.91
45.08
55.91

3.17
3.88
2.18

-0.97
-0.97
-0.96

0.41
0.46
0.35

46.26
46.26
29.37

1.16
1.39
0.93

2.75
3.28
2.07

- 1.00
-1.00
- 1.00

0.36
0.42
0.30

38.38
38.38
26.00

1.60
1.45
1.72

-0.98
-0.92
-0.98

0.35
0.56
0.15

27.90
17.86
27.90

0.70
0.87
0.54

1.59
1.44
1.71

-1.00
- 1.00
-1.00

0.34
0.55
0.14

27.57
16.60
27.57

1.53
1.49
1.56

-0.99
-0.96
-0.99

0.36
0.57
0.19

18.57
15.81
18.57

0.73
0.89
0.57

1.53
1.48
1.55

- 1.00
-1.00
- 1.00

0.34
0.56
0.18

18.36
15.66
18.36

Panel A: December/losers

Entire
First
Second

1.63
1.96
1.30

Panel B: JuneJlosers

Entire
First
Second

1.32
1.64
1.01

Panel C: December/winners

Entire
First
Second

0.72
0.89
0.55

Panel D: JuneJwinners

Entire
First
Second

0.75
0.91
0.59

If a firm is delisted during the five-year post-ranking period, then returns up to the delisting date and
the liquidating dividend, if available, are included in calculating the firms return over the postranking period. Adjusted returns are calculated by adding $4 to the price of each stock at the end of
the ranking period.

median five-year returns on winners and losers are 49% and 35%, respectively,
thus differing by only 14% (this is nut an annualized rate). Medians therefore tell
a noticeably different story about contrarian stock selection than means.
Low-priced stocks contribute to the right-skewedness of returns. Equitable
Office Building Corporation, one of the six lowest-priced six-cent loser stocks,
earned a + 3500% return. This motivates us to investigate below the effect of
the low-priced loser stocks on mean returns.

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adjusted returns

Table 2 also reports the effect on returns of adjusting upward, by $$, the
purchase prices of all stocks at the end of the ranking period. This adjustment
fulfills two objectives. First, it calibrates the sensitivity of average rate of return
estimates to a small dollar amount of either mispricing or microstructure
factors. Second, $i is a conservative estimate of the combined bid-ask spread,
brokerage commissions, and liquidity costs that might be considered part of the
cost of trading in stocks.
There is a dramatic 25% reduction in the average return on the loser portfolio
with the $4 price adjustment, from 163% to 138%. In contrast, the average for
winners falls by only 2%, from 72% to 70%, and the median return on losers
declines only from 49% to 44%. The loser stocks low prices, together with the
sensitivity of their returns to even small increases in opening prices, highlights
the potential importance of microstructure effects in this context.
3.1.4. June-end vs. December-end

holding periods

DeBondt and Thaler (1985, p. 799) note that the choice of December-end
portfolio formation dates is essentially arbitrary. The contrarian strategy
should be profitable when implemented in other months. On the other hand, the
evidence in Roll (1983a), Lakonishok
and Smidt (1984), Keim (1989), and
Bhardwaj and Brooks (1992) suggests that microstructure-related
effects on
measured returns are most pronounced at the calendar year-end, which is
precisely the point at which contrarian portfolios typically are assumed to be
formed (DeBondt and Thaler, 1985,1987; Chan; Ball and Kothari; and Chopra
et al.). In addition, Zarowin (1990) studies a June-end strategy in testing
for a January/size-related
overreaction effect, and obtains different results.
(His strategy is based on quintiles, not extreme winners and losers, so his
contrarian portfolios are quite different from ours. For example, his Juneend contrarian portfolio beta estimated from monthly returns is 0.10, while
ours estimated from annual returns is 0.78. He also focuses on initialmonth returns, i.e., January and July.) We therefore test whether measured
contrarian portfolio returns are biased by some systematic or chance December-end effect.
The mean contrarian portfolio return is much lower for June-ends, even
though the December- and June-end periods are almost identical (they share
53; of the 54 years). The 132% loser-stock average return is 31% lower than the
163% equivalent for December-end peirods. For winner stocks, whether the
period ends in December or June does not make a material difference. This is
not surprising, since most winners are not low-priced. The average five-year
return on a June-end contrarian portfolio is 57% (132% - 75%, panels C and
D), compared to the 91% average on the December-end contrarian portfolio
(163% - 72%, panels A and B). This 34% decline in average return, due to the
seemingly innocuous difference of investing at the end of June rather than

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December, shows that, whether or not there is overreaction, at least one other
factor affects the December-end prices of extreme loser stocks.
To be sure that the difference in results is not due to our accidentally
discovering a June-end anomaly, we also analyze an August-end sample. The
performance of the August-end sample (not reported) is virtually indistinguishable from that of the June-end sample.
One explanation is that small stocks trade at bid prices more frequently at the
end of December (Roll, 1983a; Lakonishok and Smidt, 1984; Keim, 1989). Loser
stocks have low average prices at the purchase date, but trade at higher average
prices at the end of the five-year period. [The mean return over the five years is
163% (see Table 2).] Measured post-ranking returns on December-end lower
stocks therefore could contain a decrease in the probability of trading at a bid
price over the period. The presence of very low-priced stocks in the loser
portfolio, with high proportionate
bid-ask spreads, could make this effect
material, even in five-year returns. This is distinct from the spread-induced bias
in cumulating average returns (Blume and Stambaugh, 1983; Roll, 1983b), which
is largely avoided by using buy-and-hold returns. The remaining bias equals
s2/4, where s is proportionate spread, and thus is relatively small.
Alternatively, there could be some other systematic or chance Decembereffect in the DeBondt and Thaler research design. One possible explanation is
that the December loser returns are related to tax-loss selling (see, for example,
Ritter and Chopra, 1989). However, we see later that the risk-adjusted performance of the contrarian strategy does not lend support for the tax-loss-selling
hypothesis.
The June-December difference seems due largely to microstructure rather
than chance factors because: (1) It is confined to loser stocks, which are
low-priced; (2) it is essentially confined to the 25% lowest-price loser stocks (see
below); (3) the 34% difference is comparable to the 25% effect of an $$ adjustment reported earlier, and thus is in the order of microstructure effects; (4) the
difference occurs in both 27-year subperiods; (5) the June- and August-end
results are similar; and (6) the data overlap in 53; of the 54 years, which makes
chance unlikely. [Keim (1989) documents the tendency of low-priced stocks to
be recorded at their bid prices at the end of December since the early 1970s. Our
evidence indirectly suggests the same phenomenon might have been occurring
since the thirties.] Whatever the explanation, the result casts doubt on the
contrarian evidence.
3.2. The relation between price and return

Because the above results show that price is related to losers post-ranking
period returns, we now explore the relation between price and return more
formally. Initially, we do this by reporting returns by price-quartile analysis and
then by regression analysis.

R. Ball et al. /Journal

of Financial

Economics

38 (1995)

79-107

89

3.2.1. Returns by price quartiles

Table 3 summarizes the post-ranking period returns of December- and
June-end winner and loser portfolios by their price quartiles. Initially, the 2700
pooled firm-period observations in each winner and loser portfolio are ranked
on their stock prices at the end of the 54 ranking periods and assigned to
price-quartile portfolios. The stocks tied for the 25th, 50th, or 75th percentile are
ranked chronologically
before assigning to quartiles. The first price-quartile
portfolio consists of the 25% lowest-priced stocks. The price distributon is
pooled over both firms and years because prior research (DeBondt and Thaler,
1985, 1987; Chan; Ball and Kothari; Chopra et al.) pools the data, and our
objective is to investigate the role of low-price loser stocks in their results. We
subsequently analyze individual-year data.
For December-end loser stocks, the 357% mean post-ranking return for
price-quartile portfolio 1 is strikingly greater than the means for portfolios
2 through 4 (113%, 96%, and 85%). The average price in this portfolio is only
$1.04. The average market capitalization is only $8 million. Comparison of the
June- and December-end results in Table 3 demonstrates that the sensitivity of
the contrarian portfolio return to the assumed end point is due almost entirely
to its very low-priced loser stocks. The lowest price quartile of the June-end loser
stocks earns 254%, on average, over the five-year post-ranking period, far less
than the 357% December-end return. This is consistent with a bias in measured
December-end contrarian returns, due to the turn-of-the-year seasonality in
bid-ask prices for low-priced loser stocks.
The effect of a $i adjustment to the opening price is dramatic for the lowest
price quartile of loser stocks. The average return on the lowest price quartile of
loser stocks declines by 86% (357% - 271%). Since most of the contrarian
portfolio return comes from the lowest price quartile, the large effect of the
$$ price adjustment and an illiquid market for the loser stocks together cast
doubt on its alleged profitability.
The reduction in average return due to
the $4 price adjustment is 55% for the lowest-price June-end loser portfolio,
much less than the December reduction, but still substantial. In contrast, all
winner-stock quartiles are relatively high-priced and their returns are essentially
unaffected by the adjustment.
An alternative to reporting contrarian portfolio performance by price quartiles
is to exclude stocks priced $1 or less. This reduces the influence of the very-lowpriced stocks whose post-ranking returns are more likely to be biased due to
microstructure factors. It also gives insight into the economic significance of
published evidence of contrarian profitability. Virtually all of the stocks priced
$1 or less are losers. The December-end loser portfolio has 359 such stocks, or
13.3% of all 2700 loser stocks. The corresponding frequency in the June-end
portfolio is 10.6%. Excluding stocks priced $1 or less has a dramatic effect on the
average return for the loser portfolio, which declines from 163% to 116%.
The corresponding numbers for the June-end portfolio are 132% and 105%.

and winner

Loser

stocks

returns

and other

characteristics:

Analysis

of price-quartile

portfolios

formed

using

pooled

samples

Mean

5-year

return

1
2
3
4

3.57
1.13
0.96
0.85

Panel A: December/losers

Price
quartile

7.13
3.39
1.80
1.45

S.D.

I.

0.95
0.24
0.49
0.44

Med.

2.71
1.04
0.93
0.84

Mean

5-year

5.60
3.22
1.77
1.44

SD.

adj. return

0.67
0.21
0.47
0.44

Med.

8.1
17.9
31.4
198.0

Mean

Market

34.0
68.8
69.7
1150

S.D.

capitalization

1.8
5.7
10.4
36.2

Med.

1.04
3.23
7.78
29.80

Mean

Price

0.51
0.85
1.87
51.60

S.D.

1.13
3.13
7.50
19.00

Med.

Descriptive
statistics for five-year
buy-and-hold
post-ranking
period returns, returns adjusted for a $$ transaction
cost, market capitalization,
and stock
prices at the end of the five-year
ranking period ending on December
31 or June 30. Samples consist of 50 best-performance
and 50 worst-performance
stocks each year from among all the NYSE and AMEX stocks that have returns available continuously
over the preceding five years (the ranking period).
The worst- and best-performance
stocks are identified
by ranking all available stocks on buy-and-hold
raw returns over the five-year
ranking
period.
There are 54 overlapping
five-year
ranking
periods ending in December
1930 (June 1931) to December
1983 (June 1984), resulting in a total of 2700
firm-period
observations
in each of the December
and June winner and loser samples. The winner and loser stocks are ranked on stock price at the end of
the five-year
ranking
period and assigned to four portfolios.
Portfolio
1 consists of the lowest-priced
25% stocks and portfolio
4 consists of the
highest-priced
25% stocks from samples of 2700 firm-period
observations.

Table

2.54
1.10
0.85
0.83

0.88
0.82
0.67
0.53

1.03
0.81
0.66
0.50

2.00
1.46
1.36
1.14

2.17
1.62
1.30
1.09

5.09
2.19
1.66
1.45

0.49
0.48
0.31
0.24

0.33
0.43
0.38
0.26

0.58
0.25
0.46
0.38

1.01
0.80
0.66
0.50

0.85
0.81
0.67
0.52

1.99
1.01
0.82
0.82

1.98
1.45
1.36
1.14

2.14
1.61
1.30
1.09

4.20
2.68
1.63
1.44

0.41
0.47
0.31
0.24

0.32
0.43
0.37
0.26

0.40
0.20
0.43
0.37

52.0
165.6
304.4
636

50.4
142.8
326.0
655.6

5.2
13.9
30.2
124.0

Portfolios
are equal-weighted.
If a firm is delisted during the five-year post-ranking
period,
the firms return over the post-ranking
period. Adjusted returns are calculated
by adding
Market
capitalization
is in millions of dollars at the end of the ranking
period.

1
2
3
4

Panel D: June/winners

1
2
3
4

Panel C: December/winners

1
2
3
4

Panel B: June/losers

18.4
60.1
110.1
208.2

16.0
56.5
116.2
232.6

1.6
5.2
10.5
31.5

13.93
28.81
43.66
92.07

12.96
27.80
42.43
90.77

1.22
3.58
8.16
28.03

5.44
3.94
5.23
62.60

5.13
3.91
5.48
63.65

0.58
0.90
1.82
25.45

14.63
28.50
42.81
75.38

13.75
28.00
41.69
74.75

1.25
3.44
8.00
28.94

then returns up to the delisting date are included in calculating

$4 to the price of each stock at the end of the ranking period.

101.0
359.9
617
1367

105.2
302.1
704.7
1368

15.4
39.6
70.2
326.7

2
2

2
g
_.

$
g
3
E.

2
2
E
e
2
23
a

92

R. Ball et al. JJournal

of Financial

Economics

38 (1995)

79-107

In the above analysis, the effects of price and time are related. While the price
distribution is comparatively stationary over long periods of time, price also has
an obvious positive relation with the market index.2 Low-priced stocks cluster
in years after large market declines. We therefore recalculate the loser portfolios
returns after omitting the three years (1930, 1940, and 1973) with the lowest
average loser-stock price. Omitting these years reduces the average loser-portfolio return from 163% to 125%. This raises further doubts that the evidence
reported in the literature reflects a general behavioral tendency for investors to
overreact in the case of extreme winner and loser stocks (the DeBondt and
Thaler, 1985, 1987, hypothesis).
This evidence implies it is unlikely that the high returns to the lowest price
quartile could be obtained from an ex ante strategy of forming price-quartile
portfolios every year, rather than pooling observations from all years. One
consequence of forming price-quartile portfolios every year is that whether or
not there are many stocks with very low prices in a given year, they are assigned
equally to all four portfolios. Thus, the lowest price quartiles performance is
contaminated by some not-so-low-priced stocks and vice versa for the highest-price-quartile
stocks. As expected, the results in Table 4 indicate that
forming quartile portfolios every year does not yield much variation in average
returns across price-quartile portfolios. Results for winner stocks are similar to
the pooled sample results in Table 3. The smallest price quartiles average price
increases, from $1.04 in Table 3 to $2;70 for the December-end loser stocks. The
average return on the lowest price-quartile stocks declines from 357% in
Table 3 to only 169% in Table 4. The $$ adjustment continues to have a dramatic effect on the smallest-price-quartile
portfolios return, however, reducing
its average return by 43%.
3.2.2. Regressionanalysis: Price vs. past return

To investigate the relation between price and post-ranking returns more

closely, we perform Fama-MacBeth
cross-sectional regressions. Each year we
regress the 100 stocks (50 winners and 50 losers) post-ranking period returns on
their prices at the end of the ranking period, and their ranking period returns.
The coefficients standard errors are calculated from the time series of coefficient
estimates. We note that since the five-year post-ranking periods are overlapping,
the annual cross-sectional regression coefficient estimates are not independent
through time. The standard errors therefore are adjusted for this dependence
using the Newey and West (1987) correction. The average estimated coefficients
on past return and price using the December-end data are - 0.14 (standard
error = 0.06) and - 0.0094 (standard error = O.OOSl), which is consistent with
both past returns and stock price predicting post-ranking period returns.

We are grateful to a referee for pointing this out.

returns

and other

characteristics:

Analysis

of price-quartile

portfolios

formed

each year

Mean
____.

5-year

return

1.69
1.88
1.47
1.50

1.17
1.44
1.46
1.23

3.30
3.61
3.18
2.45

4.93
4.87
3.13
3.94

S.D.

0.19
0.39
0.46
0.59

0.34
0.48
0.48
0.67

Med.

0.85
1.24
1.36
1.19

1.16
1.59
1.34
1.44

Mean

5-year

2.52
3.05
2.96
2.38

3.41
4.01
2.82
3.73

SD.
_____~-~

adj. return

0.08
0.35
0.43
0.58

0.23
0.42
0.45
0.65

Med.

9.1
18.6
32.9
117.1

11.7
25.9
35.6
188.7

Mean

Market

Portfolios are equal-weighted.

If a firm is delisted during the five-year post-ranking
period,
the firms return over the post-ranking
period. Adjusted returns are calculated
by adding
Market
capitalization
is in millions of dollars at the end of the ranking
period.

1
2
3
4

Panel B: June/losers

1
2
3
4

Panel A: December/losers

Price
quartile

3.2
5.7
10.4
26.2

4.2
5.7
11.0
26.3

Med.

2.88
6.06
10.45
21.97

2.70
5.77
9.80
23.90

Mean

Price

-__

3.20
6.50
11.45
27.06

3.27
6.04
10.67
53.44

S.D.
-

2.00
4.63
7.88
14.63

1.75
4.25
7.18
14.13

Med.

then returns up to the delisting date are included in calculating

$$ to the price of each stock at the end of the ranking
period.

19.8
45.5
63.9
337.4

23.8
121.0
100.8
1168

SD.

capitalization

Descriptive
statistics for five-year
buy-and-hold
post-ranking
period returns, returns adjusted for a $$ transaction
cost, market capitalization,
and stock
prices at the end of the five-year ranking period ending on December
31 or June 30. Samples consist of 50 worst-performance
stocks each year from among
all the NYSE and AMEX
stocks that have returns available continuously
over the preceding five years (the ranking period). The worst-performance
stocks
are identified by ranking all available stocks on buy-and-hold
raw returns over the five-year
ranking period. There are 54 overlapping
five-year
ranking
periods ending in December
1930(June
1931) to December
1983 (June 1984), resulting in a total of 2700 firm-period
observations
in each of the December
and June loser samples. The loser stocks are ranked on stock price at the end of the five-year
ranking
period and assigned to four portfolios
each year.
Portfolio
1 consists of the lowest-priced
25% stocks and portfolio
4 consists of the highest-priced
25% stocks each year.

Table 4
Loser stocks

94

R. Ball et al. /Journal of Financial Economics 38 (199.5) 79-107

Thus, risk considerations aside, the cross-sectional behavior of raw returns is

consistent with both low-price/microstructure
and contrarian effects.
This result complements Conrad and Kaul (1993) and Bhardwaj and
Brooks (1992), who find that price and the turn-of-the-year seasonal in
bid-ask prices are the primary determinants of January returns, and perhaps
of the contrarian strategies measured returns. Both employ a pooled sample
design.
Zarowin (1990) argues that contrarian strategy returns are another manifestation of the size effect. Therefore, we also estimate annual cross-sectional
regressions in which the natural log of market capitalization (size) is included.
The average estimated coefficient on size is not significant (p-value > 0.75)
but the average estimated coefficients on past return and stock price remain
significant. For the June-end sample, size again is insignificant, past return
is significant, and prick is marginally significant (t-statistic = 1.50). The insignificant coefficient on size is of interest because it brings into question the use
of size-adjusted returns by Chopra et al. as a control for expected returns in
this context. If price is a better proxy than size for risk or microstructure bias
in the post-ranking period returns, then it provides a superior control.
The conclusion that price dominates size in explaining contrarian raw
returns is consistent with Conrad and Kaul (1993). However, they conclude
that past performance has no predictive power for contrarian raw returns
once price is held constant. They use three-year, rather than five-year, returns.
They estimate pooled time-series and cross-sectional regressions, but do not
take into account the considerable cross-sectional correlation between returns
on losers or winners. Thus, it is difficult to interpret their reported
t-statistics.

4. Contrarian portfolio abnormal returns

The preceding analysis of the importance of past returns, size, and price in
explaining post-ranking returns is intended only to highlight the difficulties
of measuring returns and attributing
them to overreaction. Since these
variables are correlated with beta, it is important to focus on risk-adjusted
returns. This section begins by briefly describing the use of intercepts
(Jensen alphas) from excess-return time-series regressions as abnormalreturn estimates. We then report abnormal-return
estimates for both the
December- and June-end contrarian strategies. Finally, we assess the sensitivity
of our results to the zero-beta rate exceeding the riskless rate and other
deviations from the Sharpe-Lintner
CAPM, discuss subperiod analysis,
provide additional evidence on the behavior of beta as a function of upand down-market
returns, and summarize our analysis of NYSE-only
stocks.

R. Ball et al. JJournal

4.1. Excess-return

of Financial

Economics

38 (1995)

79-107

95

time-series regressions

We report intercepts from time-series regressions of annual portfolio excess

returns on those of an equal-weighted
market index. Assuming the
Sharpe-Lintner CAPM version is true and the index adequately proxies for the
market portfolio, market (informational)
efficiency requires that the index be
mean variance efficient and the intercepts be zero. As Chopra et al. emphasize,
the empirical relation between estimated betas and average returns tends to be
flatter than that implied by the Sharpe-Lintner model. Fama and French (1992)
suggest that it may even be zero. If the market index is efficient, but with
a zero-beta rate higher than the riskless rate, then the excess-return time-series
methodology overestimates the contrarian strategys expected performance,
conditional on the market. This follows since the strategy is long in a relatively
high beta portfolio (losers) and short in a significantly lower beta portfolio
(winners). Hence, Chopra et al. argue, Jensen alphas understate the stock
markets tendency to overreact and the zero-beta methodology is preferable.
We offer the following responses. First, zero-beta rate estimates are not very
precise and may be biased upward due to the well-known errors-in-variables
problem, so interpretation of the relatively low empirical slope is unclear. As
a practical matter, however, it is easy to adjust the Jensen alphas to accommodate alternative zero-beta rates, and we do this in order to assessthe robustness of
our conclusions. Second, estimates of the equal-weighted market risk premium
based on annual data, as reported by Kothari, Shanken, and Sloan (1994), are
substantial. They range from 9% to 12% per annum for the period 1927-90 and
about 6% to 9% for the 1941-90 period considered by Fama and French.
Related evidence also appears in Chan and Lakonishok (1993) and Jagannathan
and Wang (1993). Third, evidence in Fama and French (1992) suggests that
smaller size and higher book-to-market
stocks expected returns exceed that
estimated using the CAPM. Their findings are relevant in evaluating contrarian
performance because of the relatively smaller size and higher book-to-market
values for losers, as compared to winners. While Kothari, Shanken, and Sloan
raise doubts about the importance of the book-to-market
variable, the
Fama-French results predict that a CAPM-based benchmark will, if anything,
understate the contrarian expected return and therefore overstate the contrarian
abnormal return.
Before turning to the empirical results, we emphasize some additional normative considerations in interpreting excess-return time-series regression results.
As is well known, the finding of a positive Jensen alpha for a portfolio implies
that the efficiency of the market index can be improved upon (i.e., the Sharpe
ratio of expected excess retufn to standard deviation can be increased) by
a marginal shift out of the index and into the portfolio. While a symmetric result
holds for negative alphas, one can make the stronger statement that no amount
of tilting the investment in the direction of a negative or zero alpha portfolio

96

R. Ball et al. /Journal

of Financial

Economics

38 (1995)

79-107

(i.e., placing positive weight on both the market index and the portfolio), will
improve upon the efficiency of the index. The improved position would have to
have a positive alpha (Dybvig and Ross, 1985a), which is impossible, since the
index has an alpha of zero. This perspective is relevant to the empirical analysis
below.
4.2. Abnormal return and beta estimates

Abnormal returns and beta risks in event-years - 4 to + 5 are estimated

using annual return data. Previous research by Ball and Kothari (1989) and
Chopra et al. (1992) uses Ibbotsons (1975) returns across time and securities
technique. We employ a modification of this technique based on Kothari and
Shankens (1992) argument that the contrarian portfolios beta should vary in
calendar time, conditional on the realized market risk premium over the ranking
period. The rationale is that if the realized premium in the ranking period is
positive, the loser portfolio is more likely to consist of low-beta stocks. Conversely, if the realized premium is negative, the loser portfolio will contain more
high-beta stocks.
We allow winner and loser portfolios betas to be a function of the market
return over the ranking-period,
by estimating the following model in each
event-year r = - 4, . . . ,O, . . . , 5:3
R,,(z) = ~~(4 + P,@) * R,, + &(4 * C&d - 490) -

Aw&I*

Rn, + &,tW ,
(1)

where R,,(z) is the annual buy-and-hold excess return on portfolio p = (winner,

loser) in calendar year t and event-year z, R, is the buy-and-hold equalweighted annual excessreturn on NYSE-AMEX
stocks in calendar year t, excess
returns are obtained by subtracting the annual return on Treasury bills
(Ibbotson and Sinquefield, 1989) up(z) is abnormal return in event-year z, /-I,(r)
is the 54-year average relative risk of portfolio p in event-year Z, AvgR, is
the time-series average of annual excess returns on the market index, while
R,,( - 4,0) is the average excess return on the market index over event years
- 4 through 0 relative to calendar year t. The deviation of a portfolios beta in
a given calendar year from its 54-year average beta, &(r), is given by the
product of 6,(z) and the unexpected market excess return over the relevant
ranking period. This can be seen by substituting AvgR, for R,,( - 4,0) in
Eq. (1). The corresponding term then drops out, leaving &,(r) as the sole
coefficient on R,,. For further details, see Kothari and Shanken (1992, Sect. 4.2)
and Jones (1993).

See Shanken (1990) for a more general application of this methodology to tests of conditional asset
pricing models.

R. Ball et aLlJournal

of Financial

Economics

38 (1995)

79-107

91

4.2.1. Abnormal return estimates

Table 5 reports abnormal return, beta, and delta estimates for the winner and
loser portfolios. In calculating the standard error of the average post-ranking
period abnormal return, beta and delta, we incorporate the dependence among
the time series of event-time regression residuals. The standard error of the
average abnormal return is only slightly smaller than that of the individual
years abnormal return estimates. This is due to strong positive correlations
among the estimates for different years. Thus, it is important not to attribute too
much significance to any consistency of results over different post-ranking years.
Details are available on request.
The December-end loser portfolio alpha averages 0.7% per year (standard
error 2.7%) over the five-year post-ranking period. In none of the five postranking years is the loser portfolios estimated abnormal return reliably positive.
The winner portfolios alphas average - 3.6% per year (standard error 1.3%)
over the post-ranking period, and are reliably negative in years 2, 3, and 4. The
December-end contrarian portfolio thus averages 4.3% abnormal return (standard error 3.4%), ignoring transaction costs (notably, costs of short-selling
winner stocks) and microstructure-related
biases. Since the contrarian portfolios estimated abnormal return is due primarily to the winner portfolio, it is
not attributable to tax-loss selling.4
The average alpha of the June-end loser portfolio is noticeably lower than its
December-end equivalent, consistent with the June- and December-end differences observed in raw returns. Its estimated abnormal return averages - 5.3%
(standard error = 2.9%) per year over the post-ranking period and is negative in
each of the five post-ranking years. This is inconsistent with the overreaction
hypothesis. Consistent with the overreaction hypothesis, the winner portfolio
loses 2.8% (standard error = 1.7%) on average per year, which is comparable to
the December-end winner portfolios performance. Combining these, the Juneend contrarian portfolio loses in each of the five years, or 2.5% on average
(standard error = 4.0%). This is without giving any consideration to transaction
costs, a particular concern when assessing benefits from investing in the relatively low-priced loser stocks. Comparison of the December- and June-end results
reveals that the loser portfolios average abnormal retun) declines noticeably
from 0.7% to - 5.3%, which is consistent with the security microstructure
biases affecting the low-priced loser stocks December-end returns. The December-end winner stocks abnormal return estimate is only marginally higher than
that of the June-end winner stocks ( - 3.6% versus - 2.8%).

4Previous evidence on the performance of portfolios formed on the basis of prior one-year returns
(e.g., DeBondt and Thaler, 1985, Table 1; Ball and Kothari, 1989, Table 5; Chopra et al., 1992,
Table 3; Jegadeesh and Titman, 1993) suggests momentum, which is also inconsistent with the
tax-loss-selling hypothesis.

Table 5
Annual abnormal return and systematic risk estimates, allowing portfolio betas to vary with the market performance over the ranking period: Decemberand June-end samples
Winner- and loser-portfolio average abnormal return, beta, and delta estimates over the five-year post-ranking periods. The ranking period ends in
December or June. The winner and loser portfolios consist of 50 best-performance and 50 worst-performance stocks each year from among all the NYSE
and AMEX stocks that have returns available continuously over the ranking period. The worst- and best-performance stocks are identified by ranking all
available stocks on buy-and-hold raw returns over the five-year ranking period. There are 54 overlapping five-year ranking periods ending in December
1930 (June 1931) to December 1983 (June 1984), resulting in a total of 54 portfolio-year observations in each event year. Beta of the winner and loser
portfolio in a given calendar year is allowed to be a function of the return on the market portfolio over the ranking period corresponding to the calendar
period.
December-end ranking
Event
year

Alpha

Panel A: Loser
1

2
3
4
5
1 to 5

portfolio

S.E.

June-end ranking
Beta

SE.

Delta

S.E.

Alpha

S.E.

Beta

SE.

Delta

S.E.

performance

4.1%
1.6
0.6
-1.5
- 1.5

3.9
3.6
3.2
3.2
3.4

1.47
1.43
1.47
1.42
1.45

0.12
0.11
0.11
0.11
0.11

0.01
-0.26
-0.13
0.07
0.20

0.12
0.14
0.17
0.16
0.17

-0.6%
-8.9
-7.2
-5.2
-4.4

4.8
4.2
3.4
4.1
2.6

1.69
1.95
1.72
1.65
1.52

0.14
0.13
0.11
0.13
0.09

-0.15
- 1.02
-0.51
- 0.22
-0.30

0.09
0.17
0.17
0.17
0.16

0.7

2.7

1.45

0.09

-0.02

0.10

-5.3

2.9

1.71

0.08

-0.44

0.09

Panel B: Winner

portfolio

performance

1
2
3
4
5

- 1.9
-4.6
-4.5
-4.0
-3.1

2.3
1.9
1.7
1.7
1.9

0.87
0.92
0.94
0.98
0.89

0.07
0.06
0.06
0.06
0.06

0.26
0.37
0.25
0.28
0.10

0.07
0.07
0.09
0.08
0.10

1.1
-3.4
-5.9
-4.2
-1.4

2.8
2.3
2.2
2.1
2.1

0.84
0.93
0.97
1.00
0.90

0.08
0.07
0.07
0.07
0.07

0.28
0.15
-0.18
0.30
0.08

0.06
0.10
0.11
0.09
0.13

1 to 5

-3.6

1.3

0.92

0.04

0.25

0.05

-2.8

1.7

0.93

0.05

0.13

0.05

Abnormal
return, beta, and delta, averaged over the five-year
Abnormal
return and beta are estimated from the following
and for both the winner and loser portfolios:

ranking and five-year

post-ranking
periods
regression using 54 annual portfolio-return

are reported
observations

for the winner and loser portfolios.

for each event-year
T = 1, 2, . . ,5

where R,,(r) is the annual buy-and-hold

excess return on portfolio
p = (winner,
loser) in calendar year t and event-year
5, R,, is the buy-and-hold
equal-weighted
annual excess return on the NYSE-AMEX
stocks in calendar year t, excess returns are obtained
by subtracting
the annual return on
Treasury
bills (Ibbotson
and Sinquefield,
1989), AuyR, is the time-series average of annual excess returns on the market index, R,,( -4,0) is the average
excess return on the market index over the ranking-period
event years - 4 through
0 relative to the calendar year t, czp is the abnormal
return on the
winner portfolio,
/I,, is the CAPM
measure of relative risk, and 6 is the sensitivity
of a portfolios
beta to the market return over the ranking
period.
Standard
errors of the five-year
above CAPM
regressions.
Standard

errors.

average

CI, p, and 6 are calculated

by incorporating

dependence

among

the time series of event-time

residuals

from

the

100

R. Ball et al. /Journal

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79-107

In summary, the contrarian strategys estimated abnormal return is sensitive

to the choice of ranking-period
end. [We also estimate, but do not report,
abnormal return and beta estimates without letting beta vary over time, i.e., the
technique in Ball and Kothari (1989). The December-end (June-end) contrarian
portfolio earns an average annual abnormal return of 4.6% ( - 1.4%), which is
greater than that reported in Table 5.1 The June-end portfolios exhibit no
evidence of economically significant profits from pursuing a contrarian portfolio
strategy. If anything, the profits appear negative.
4.2.2. Systematic risk and delta estimates

The systematic risk estimates behave as documented in previous research. The

loser portfolios beta exceeds the winner portfolios beta, consistent with the
changes in leverage caused by their ranking-period performances (Chan, 1988;
Ball and Kothari, 1989). The deltas are generally consistent in sign with the
hypothesized relation between the riskiness of stocks assigned to the winner and
loser portfolios and the market performance over the ranking period. As
a result, the contrarian deltas are reliably negative (see Table 6), indicating that
relative risk is lower when the ranking period market return is high.
Table 6
Winner, loser, and contrarian portfolios abnormal return and beta estimates, allowing portfolio
betas to vary with the market performance over the ranking period: Entire period and subperiod
analysis of December- and June-end samples
Winner-, loser-, and contrarian-portfolio average abnormal return, beta, and delta estimates over
the five-year post-ranking periods. The ranking period ends in December or June. The winner and
loser portfolios consist of 50 best-perfomance and 50 worst-performance stocks each year from
among all the NYSE and AMEX stocks that have returns available continuously over the ranking
period. The worst- and best-performance stocks are identified by ranking all available stocks on
buy-and-hold raw returns over the five-year ranking period. There are 54 overlapping five-year
ranking periods ending in December 1930 (June 1931) to December 1983 (June 1984), resulting in
a total of 54 portfolio-year observations in each event year. The first and second periods split the
entire period in the middle. Beta of the winner and loser portfolio in a given calendar year is allowed
to be a function of the return on the market portfolio over the ranking period corresponding to the
calendar period.
December-end ranking
Period
Panel A: Loser

Event
years
portfolio

Entire

1 to 5

First

1 to 5

Second

1 to 5

Alpha
S.E.

June-end ranking

Beta
S.E.

Delta
SE.

Alpha
S.E.

Beta
S.E.

Delta
S.E.

1.45
0.09
0.72
0.11
1.19
0.08

-0.02
0.10
0.08
0.12
-0.12
0.11

-5.3%
2.9
-10.6
4.1
-1.1
2.0

1.71
0.08
2.14
0.11
1.29
0.08

-0.44
0.09
-0.49
0.10
-0.41
0.18

performance

0.7%
2.7
-4.2
4.2
3.1
1.9

R. Ball et al. JJournal

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101

79-107

Table 6 (continued)
December-end ranking
Event
years

Period

Panel B: Winner

Alpha
S.E.

portfolio

Entire

1 to 5

First

Second

1 to 5

Entire

1 to 5

First

1 to 5

Second

1 to 5

Delta
SE.

Alpha
S.E.

Beta
SE.

Delta
SE.

performance

-3.6%
1.3
-0.7
1.2
-6.1
2.0

to 5

Panel C: Contrarian

Beta
S.E.

June-end ranking

portfolio

0.92
0.04
0.85
0.04
0.98
0.08

0.25
0.05
0.24
0.04
0.25
0.11

-2.8%
1.7
1.7
1.8
-5.8
1.8

0.93
0.05
0.70
0.05
1.25
0.07

0.13
0.05
0.09
0.05
0.47
0.15

0.53
0.12
0.87
0.16
0.20
0.12

-0.28
0.11
-0.16
0.14
-0.37
0.18

-2.5%
4.0
-12.3
5.4
4.7
2.4

0.78
0.11
1.34
0.14
0.04
0.10

-0.57
0.12
-0.58
0.13
-0.88
0.21

performance

4.3%
3.4
- 3.4
4.8
9.3
3.0

Abnormal return, beta, and delta, averaged over the five-year ranking and five-year post-ranking
periods are reported for the winner, loser, and contrarian portfolio. Abnormal return, beta, and delta
are estimated from the following regression using 54 annual portfolio-return observations for each
event-year 7 = 1,2, . ,5 and for both the winner and loser portfolios:
R,tW = ~(4 + &(d*Rmt + ~pWIL(-

4>0) - &&,,I

*R,, + ~pt(+

where R,,(z) is the annual buy-and-hold excess return on portfolio p = (winner, loser) in calendar
year t and event-year r, R,, is the buy-and-hold equal-weighted annual excess return on the
NYSE-AMEX
stocks in calendar year t, excess returns are obtained by subtracting the annual
return on Treasury bills (Ibbotson and Sinquefield, 1989), AugR, is the time-series average of annual
excessreturns on the market index, R,,( -4,0) is the average excessreturn on the market index over
the ranking-period event years - 4 through 0 relative to the calendar year t, Q is the abnormal
return on the winner portfolio, /I, is the CAPM measure of relative risk, and 6 is the sensitivity of
a portfolios beta to the market return over the ranking period.
Standard errors of the five-year average a, fi, and 6 are calculated by incorporating dependence
among the time series of event-time residuals from the above CAPM regressions.

4.3. Robustnesstests
4.3.1. Zero-beta rate exceeding the riskless rate

The preceding analysis relies on the Sharpe-Lintner version of the CAPM to

interpret Jensen alphas as abnormal returns. We now examine whether the
June-end contrarian portfolio earns abnormal returns, assuming the market

102

R. Ball et al.lJournal of Financial Economics 38 (1995) 79-107

index is on the stock-only efficient frontier with a zero-beta rate that exceeds the
riskless rate. It is easy to show that the estimated abnormal return of the
contrarian portfolio using the zero-beta CAPM then exceeds its Jensen alpha by
approximately fi,(R, - Rf), where PCis the contrarian portfolios average beta
and R, is the zero-beta rate. The June-end contrarian portfolios beta estimate is
0.78 (see Table 6, which summarizes results for the entire time period and two
subperiods of 27 calendar years). Therefore, even if the zero-beta rate exceeds the
(riskless) T-bill rate by 5% (the approximate estimate of Chopra et al.) then the
June-end contrarian portfolios estimated abnormal return increases from
- 2.5% (see Table 5) to + 1.4%, which is only 0.35 standard errors above zero.
(The r-statistic for the December-end strategy is about 2 in this case.) The
average June-end contrarian abnormal return does not produce a t-statistic
greater than 2 until the annual zero-beta rate is 13.3% above the T-bill rate. The
average return on the market index is then only about 1% greater than the
zero-beta rate. Thus, the lack of evidence of contrarian profitability for the
June-end strategy is not limited to a particular version of the CAPM.
4.3.2. Subperiod analysis

Table 6 reports that the December-end contrarian strategy is not profitable in

the first subperiod (average annual abnormal return of -3.4%), but it yields
a large average annual abnormal return of 9.3% in the second subperiod. The
profitability in the second period is driven largely by the significant -6.1%
(standard error 2.0%) abnormal return of the December-end winner portfolio.
Since we had no prior theoretical reason to focus on the second subperiod,
aggregating the abnormal-return t-statistics over the two periods is more appropriate than emphasizing the maximum. Assuming the statistics are approximately independent standard normal variates, the aggregated t-statistic is 1.69.
The June-end contrarian portfolio has - 12.3% average annual abnormal
return in the first subperiod, but earns 4.7% in the second. The contrarian
portfolio is very risky in the first subperiod (December-end and June-end betas =0.87 and 1.34), but not in the second (December-end and June-end betas = 0.20 and 0.04). The June-end portfolio deltas are nontrivial in both subperiods (-0.58 and -0.88), however, indicating that the beta varies considerably
over time. Allowing betas to vary reduces the estimated abnormal returns for the
June-end strategy by 3.8% in the first subperiod and 2.3% in the second.
The evidence that the contrarian strategy does not exhibit positive abnormal
performance in the first period is somewhat surprising, because Fama and French
(1988) and other previous research indicates that serial correlation in index
returns is observed predominantly in the pre-World War II period. We therefore
expect the contrarian strategy to be profitable, if at all, in the first subperiod, not
the second. The reversal of the contrarian strategys profitability over the subperiods is an additional reason to exercise caution in evaluating claims that
contrarian rules reliably beat the market.

R. Ball et al. /Journal

4.3.3. Up-and down-market

of Financial

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38 (1995)

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103

betas

The preceding analysis assessesportfolio performance in the context of the

mean-variance framework of the CAPM and previously documented deviations
from that model. DeBondt and Thaler (1987) express reservations concerning
the use of beta as a risk measure since, as they report (Table 4) the contrarian
portfolio beta is 0.40 in up markets and -0.32 in down markets. Chopra et al.
(1992, Table 7) report corresponding betas of 1.05 and 0.27. Thus, there is a sense
in which contrarian returns exhibit a desirable form of risk that is not recognized
in the mean-variance framework. We find similar results (available on request)
even after allowing for variation in ex ante betas over time, as discussed earlier.
It is important to emphasize, however, that the appealing up- and down-market
behavior of beta is accompanied by an unappealing negative alpha, - 4.3% for
the December-end and - 17.6% for the June-end strategy. In addition, Jones
(1993) reports that the seemingly desirable up- and down-market beta behavior
largely disappears over the post-war period.
The evidence of different up- and down-market betas means that expected
contrarian returns, conditional on the ex post market return, are not linear in
the market return. This linearity condition is satisfied under joint normality and
certain other return distributions that are often used to motivate mean-variance
analysis (see Stapleton and Subrahmanyam, 1983). Therefore, it may be important to explore other utility frameworks and associated equilibrium
benchmarks, for example, a skewness preference model (Kraus and Litzenberger, 1976;
Rubinstein, 1973). We leave for future research the task of evaluating the
tradeoff between the behavior of beta and the negative contrarian alpha in such
a framework.
4.3.4. Exclusion of low-priced

stocks

When stocks priced less than $1 are excluded, the December-end loser
portfolio post-ranking period average abnormal return declines from 0.7% to
0.1%. The corresponding numbers for the June-end portfolio are - 5.3% and
- 4.6%. Thus, the basic conclusion that the June-enQ contrarian investment
strategy is not profitable is not altered when restricted to stocks priced greater
than $1 at the beginning of the post-ranking period.
4.3.5. NYSE firms only

Our sample consists of extreme-performance stocks selected from a universe

that includes AMEX stocks, beginning in July 1962. It therefore differs from
samples in previous research using only NYSE stocks. We include AMEX
stocks because they typically have lower market capitalization and are less
closely followed by analysts; thus they would seem to give the overreaction
hypothesis its best shot. Of course, the microstructure factors discussed earlier
are likely to be more influential as well. There are reasons to believe, however,
that excluding AMEX stocks would not alter the tenor of our results. First,

104

R. Ball et al. /Journal of Financial Economics 38 (1995) 79-107

notwithstanding some of the sample-selection differences, our evidence for the

December-end portfolios is similar to that reported in Ball and Kothari and
Chopra et al. for NYSE-only samples. The December-end contrarian portfolio
in Ball and Kothari earns an average Sharpe-Lintner abnormal return of 3.9%
compared to 2.5% in Chopra et al. and 4.3% in our examination. Second, the
June versus December differences are similar in both subperiods, even though
the first subperiod contains no AMEX stocks.
We replicate all results on a NYSE-only sample. The full results are available
on request. The raw as well as abnormal return results are virtually unchanged.
For example, in panel A of Table 3 we report (for the full sample of December-end loser-stock price quartiles) average prices of $1.04, $3.23, $7.78, and
$29.80. For the NYSE-only sample, the equivalent figures are $1.27, $3.98, $8.94,
and $31.20. Similarly, the average post-ranking returns for the full sample
price-quartiles are 357%, 113%, 96%, and 85%; for the NYSE-only sample,
equivalent figures are 346%, llO%, 98%, and 82%.
The abnormal-return analysis reveals only small differences when NYSE-only
stocks are examined. For example, excluding AMEX stocks reduces the second-period December-end contrarian abnormal return, from 9.3% to 6.8%,
whereas for the June-end portfolio it increases from 4.7% to 5.0%. Recall that
the first subperiod results are unaffected, because AMEX stocks came on line
only in mid-1962. For the entire period, the December-end contrarian portfolios average alpha is 2.9% for the NYSE-only sample, compared to 4.3% for
the NYSE-AMEX
sample. The corresponding figures for the June-end sample
are - 2.3% and - 2.5%.

5. Conclusions

We explore a variety of performance measurement problems, in the context of

a DeBondt and Thaler (1985, 1987) contrarian research design. The first set of
issues is concerned with the measurement of raw returns. We show that much of
the reported profitability of a contrarian strategy is driven by low-priced loser
stocks. The skewness in rates of return due to low-priced stocks is so pronounced
that, while winner and loser five-year means differ by 91% (the result that
stimulated the contrarian literature), their medians differ by only 14%. Loserstock prices are so low that their subsequent five-year returns are extremely
sensitive to even a $i of either mispricing or microstructure-induced
effect.
Worse, the low prices tend to bunch in a very few years following bear
markets, so price-related microstructure effects in the DeBondt and Thaler
(1985, 1987) research design are entangled with problems in specifying expected
returns for low-priced stocks in particular market settings. Surprisingly, ignoring
transaction costs and simply changing the month in which trading is initiated
(from June-end to December-end) drastically reduces the (raw and abnormal)

R. Ball et al. /Journal

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38 (1995)

79-l 07

105

returns of the lower-priced loser stocks. This is consistent with the previously
documented tendency for the prices of low-capitalization
stocks to be recorded
at the bid at the end of December (Roll, 1983a; Lakonishok and Smidt, 1984;
Keim, 1989; Bhardwaj and Brooks, 1992). Because the December-end evidence
is likely to be biased due to the microstructure factors discussed earlier, we give
greater credence to the June-end (and similar August-end) results. Whatever the
source of the difference, it implies that the DeBondt and Thaler (1985, 1987)
estimates of contrarian portfolio performance are far from robust,
Using the Jensen alpha measure of abnormal return and allowing betas to
vary over time, we find limited evidence of positive abnormal performance for
the December-end contrarian portfolio, but negative abnormal performance for
the June-end portfolio, even ignoring microstructure effects and transactions
costs. Since the December-end contrarian portfolio derives its abnormal return
primarily from the winner portfolio, its profitability cannot be attributed to
year-end tax-loss selling. When an empirical security market line is used to
evaluate performance, as suggested by Chopra et al., there is still no reliable
evidence of positive abnormal returns for the June-end strategy. The book-tomarket and size effects reexamined recently by Fama and French (1992), and the
spread effect explored by Amihud and Mendelson (1986) if considered, would
only serve to increase the expected return and thus reduce the measured
abnormal returns. We conclude that the lack of evidence of contrarian profitability for the June-end strategy is not limited to a particular version of the
CAPM.
Measurement problems thus are apparent in both raw and abnormal fiveyear buy-and-hold contrarian portfolio returns. Such problems are unusually
severe for contrarian portfolios because they invest in extremely low-priced
loser stocks. Therefore, performance measures for contrarian portfolios in
DeBondt and Thaler (1985, 1987) Chan (1988), Ball and Kothari (1989),
Chopra, et al. (1992), and Jones (1993) deserve some skepticism. Many of the
issues we raise could be relevant in other portfolio performance measurement
contexts.
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