Does the stock market Overreact? of the empirical analysis are similar and that the choice does not affect our main conclusions. Therefore, we will only report the results based on market-adjusted excess returns. The residuals are estimated as ujt=Rjt-Rmt. There is no risk adjustment except for movements of the market as a whole and the adjustment is identical for all stocks. Since, for any period t, the same(constant) market return Rmt is subtracted from all R; s, the results are interpretable in terms of raw(dollar)returns. As shown in De Bondt [7], the use of market-adjusted excess returns has the further advantage that it is likely to bias the research desig against the overreaction hypothesis. Finally, De Bondt shows that winner and loser portfolios, formed on the basis of market-adjusted excess returns, do not systematically differ with respect to either market value of equity, dividend yield We will now describe the basic research design used to form the winner and loser portfolios and the statistical test procedures that determine which of the two competing hypotheses receives more support from the data. A. T'est Procedures: Details Monthly return data for New York Stock Exchange(NYSE) common stocks, as compiled by the Center for Research in Security Prices(CRSP)of the University of Chicago, are used for the period between January 1926 and December 1982. An equally weighted arithmetic average rate of return on all CRSP listed securities serves as the market index 1. For every stock j on the tape with at least 85 months of return data( months 1 through 85), without any missing values in between, and starting in January 1930(month 49), the next 72 monthly residual returns ujt(months 49 through 120)are estimated. If some or all of the raw return data beyond month 85 are missing, the residual returns are calculated up to that point. The procedure is repeated 16 times starting in January 1930, January 1933,..., up to January 1975. As time goes on and new securities appear on the tape, more and more stocks qualify for this step. 2. For every stock j, starting in December 1932(month 84; the " portfolio formation date")(t=O), we compute the cumulative excess returns CUj Ei=-35 Ujt for the prior 36 months(the"portfolio formation period, months 49 through 84). The step is repeated 16 times for all nonoverlapping three year periods between January 1930 and December 1977. On each of the 1 relevant portfolio formation dates(December 1932, December 1935, December 1977), the CU,'s are ranked from low to high and portfolios are formed. Firms in the top 35 stocks(or the top 50 stocks, or the top decile) are assigned to the winner portfolio W; firms in the bottom 35 stocks(or the bottom 50 stocks, or the bottom decile)to the loser portfolio L. Thus, the portfolios are formed conditional upon excess return behavior prior to t 0, the portfolio formation date. 3. For both portfolios in each of 16 nonoverlapping three-year periods(n 3 We will come back to this bias in Section II