Testing for the success and the use of contrarian strategies in İstanbul Stock Exchange

Abstract

This thesis analyses an anomaly, namely the Overreaction Hypothesis, which is a widely studied behavioural finance approach that has challenged the Efficient Market Hypothesis. The Overreaction Hypothesis states that extreme movements in the stocks prices will be followed by subsequent movements in the opposite direction; i.e. past losers significantly outperform past winners, which is a violation of the weak form efficiency. We examine the presence of such price correction and the success of contrarian strategies in İstanbul Stock Exchange (ISE) for the period of 1986 to 2001. We use a modified version of De Bondt and Thaler’s methodology to form winner, loser and arbitrage portfolios of one, two and three year formation / test periods. We find out that for all formation / test periods, there is a substantial price correction in the market, which supports the Overreaction Hypothesis and the profitability of contrarian strategies. Our evidence may indicate that ISE is not weak form efficient. Furthermore, we inspect the foreign investors’ behaviour and its effects in ISE. A significant relation between foreign investors purchase or sales decision and the return of the stocks is detected. It is also found that foreign investors behave rationally since they use contrarian strategies in ISE.