An Empirical Evidence of Over Reaction Hypothesis on Karachi Stock Exchange (KSE)

Abstract

Purpose: There is extensive international evidence that contrarian strategy yields positive abnormal returns for long-term periods. However, this topic has received scarce attention in Pakistan. This research study in line with De Bondt and Thaler (1985) examines the winner-loser anomaly on Karachi Stock Exchange (KSE) using cumulative abnormal returns (CAR). Design/Methodology: To substantiate the purpose, this study has calculated cumulative abnormal returns (CAR) of each company listed on KSE for a period of 2000-2015 and constructed both the corresponding Equally Weighted and Value Weighted portfolios returns. To check the risk adjusted performance of these portfolios, a system-based estimation via the Generalized method of moments (GMM) with Newey-West standard errors corrected for heteroscedasticity and serial correlation is employed. Findings: This study reports significant evidence of Contrarian Investment strategies in KSE over the entire sample period. Results show that both Equally Weighted and Value Weighted portfolios formed on CAR generates abnormal returns of 9.89% and 3.64% per annum in the long run on KSE. Further a system of equations based on Generalized Methods of Moments (GMM) showed that Capital Asset Pricing Model (CAPM) is misspecified in case of KSE as it fails to explain the cross-sectional variation in portfolios returns based on contrarian investment strategies but 3-factor and 5-factor (Fama and French, 1996;2016) have explained their risk-adjusted abnormal return. Research Limitation/Implications: The study can be improvised by including other fundamentals and macroeconomic variables and determining their impact on contrarian investment strategies in different sectors and markets of Pakistan. Practical Implications: Policymakers and Investors need to take in to account contrarian investment strategies for evaluating asset returns. Contrarian Investment strategies are profitable in the long run on KSE and investors when taking their portfolio selection decisions can long the portfolios with lowest CAR value shares and short the higher CAR values portfolios. Originality/Value: The study aims to make the first attempt in investigating the risk adjusted performance of portfolios based on contrarian strategies by using not only CAPM but also 3-factor and 5-factor Fama and French (1996;2016) on Karachi Stock exchange.