Underreaction,Momentum Trading,and Overreaction 2147 sections of individual stocks(Jegadeesh and Titman(1993))and for a variety of broad asset classes(Cutler,Poterba,and Summers(1991)).6 One possible interpretation of this unconditional evidence-which fits with the spirit of the model below-is that information which is initially private is incorpo- rated into prices only gradually. Second,conditional on observable public events,stocks tend to experience post-event drift in the same direction as the initial event impact.The types of events that have been examined in detail and that fit this pattern include: Earnings announcements (perhaps the most-studied type of event in this genre;see e.g.,Bernard (1992)for an overview);stock issues and repur- chases;dividend initiations and omissions;and analyst recommendations.? Recent work by Chan,Jegadeesh,and Lakonishok (1996)shows that these two types of continuation are distinct:In a multiple regression,both past returns and public earnings surprises help to predict subsequent returns at horizons of six months and one year. B.Reversals and Fundamental Reversion One of the first and most influential papers in the reversals category is DeBondt and Thaler(1985),who find that stock returns are negatively cor- related at long horizons.Specifically,stocks that have had the lowest returns over any given five-year period tend to have high returns over the subsequent five years,and vice versa.8 A common interpretation of this result is that when there is a sustained streak of good news about an asset,its price overshoots its "fundamental value"and ultimately must experience a correction.More re- cent work in the same spirit has continued to focus on long-horizon predict- ability,but has used what are arguably more refined indicators of fundamental value,such as book-to-market,and cash flow-to-price ratios.(See,e.g.,Fama and French(1992)and Lakonishok,Shleifer,and Vishny (1994).)9 C.Is It Risk? In principle,the patterns noted above could be consistent with traditional models,to the extent that they reflect variations in risk,either over time or across assets.Fama and French (1993,1996)argue that many of the long- 6 Rouwenhorst(1998,1999)finds that Jegadeesh and Titman's(1993)U.S.results carry over to many other developed and emerging markets,though they are not statistically significant for every country individually (see,e.g.,Haugen and Baker(1996)on weak momentum in Japan). 7 References include:Bernard and Thomas(1989,1990)on earnings announcements;Lough- ran and Ritter(1995)and Spiess and Affleck-Graves(1995)on stock issues;Ikenberry,Lakon- ishok,and Vermaelen(1995)on repurchases;Michaely,Thaler,and Womack(1995)on dividend initiations and omissions;and Womack(1996)on analyst recommendations. 8 These results have been controversial,but seem to have stood up to scrutiny (Chopra, Lakonishok,and Ritter(1992)).There are also direct analogs in the time series of aggregate market returns,although the statistical power is lower.See Fama and French(1988),Poterba and Summers (1988),and Cutler,Poterba,and Summers (1991). s These results have also been found to be robust in international data.(Fama and French (1998),Rouwenhorst (1999))And again,there are analogous fundamental reversion patterns in the time-series literature on aggregate market predictability (Campbell and Shiller(1988)).sections of individual stocks ~Jegadeesh and Titman ~1993!! and for a variety of broad asset classes ~Cutler, Poterba, and Summers ~1991!!. 6 One possible interpretation of this unconditional evidence—which fits with the spirit of the model below—is that information which is initially private is incorpo￾rated into prices only gradually. Second, conditional on observable public events, stocks tend to experience post-event drift in the same direction as the initial event impact. The types of events that have been examined in detail and that fit this pattern include: Earnings announcements ~perhaps the most-studied type of event in this genre; see e.g., Bernard ~1992! for an overview!; stock issues and repur￾chases; dividend initiations and omissions; and analyst recommendations.7 Recent work by Chan, Jegadeesh, and Lakonishok ~1996! shows that these two types of continuation are distinct: In a multiple regression, both past returns and public earnings surprises help to predict subsequent returns at horizons of six months and one year. B. Reversals and Fundamental Reversion One of the first and most influential papers in the reversals category is DeBondt and Thaler ~1985!, who find that stock returns are negatively cor￾related at long horizons. Specifically, stocks that have had the lowest returns over any given five-year period tend to have high returns over the subsequent five years, and vice versa.8 A common interpretation of this result is that when there is a sustained streak of good news about an asset, its price overshoots its “fundamental value” and ultimately must experience a correction. More re￾cent work in the same spirit has continued to focus on long-horizon predict￾ability, but has used what are arguably more refined indicators of fundamental value, such as book-to-market, and cash flow-to-price ratios. ~See, e.g., Fama and French ~1992! and Lakonishok, Shleifer, and Vishny ~1994!.!9 C. Is It Risk? In principle, the patterns noted above could be consistent with traditional models, to the extent that they reflect variations in risk, either over time or across assets. Fama and French ~1993, 1996! argue that many of the long- 6 Rouwenhorst ~1998, 1999! finds that Jegadeesh and Titman’s ~1993! U.S. results carry over to many other developed and emerging markets, though they are not statistically significant for every country individually ~see, e.g., Haugen and Baker ~1996! on weak momentum in Japan!. 7 References include: Bernard and Thomas ~1989, 1990! on earnings announcements; Lough￾ran and Ritter ~1995! and Spiess and Affleck-Graves ~1995! on stock issues; Ikenberry, Lakon￾ishok, and Vermaelen ~1995! on repurchases; Michaely, Thaler, and Womack ~1995! on dividend initiations and omissions; and Womack ~1996! on analyst recommendations. 8 These results have been controversial, but seem to have stood up to scrutiny ~Chopra, Lakonishok, and Ritter ~1992!!. There are also direct analogs in the time series of aggregate market returns, although the statistical power is lower. See Fama and French ~1988!, Poterba and Summers ~1988!, and Cutler, Poterba, and Summers ~1991!. 9 These results have also been found to be robust in international data. ~Fama and French ~1998!, Rouwenhorst ~1999!! And again, there are analogous fundamental reversion patterns in the time-series literature on aggregate market predictability ~Campbell and Shiller ~1988!!. Underreaction, Momentum Trading, and Overreaction 2147