The reference dependency of short-term reversal

Abstract

The short-term reversal anomaly has been believed to be compensation for liquidity provision. We put forth the hypotheses that i) liquidity provision for a stock increases with the stock's capital gains overhang and ii) short-term reversal is more pronounced for the stocks with a large capital loss overhang. Our empirical findings support our hypotheses and the results hold firmly, even after we control for risk as well as lottery preferences and past return effects. We also document that this reference dependency of short-term reversal is stronger among stocks with low institutional ownership and during the low liquidity period.