Long-term Reversals. Every three years from 1926 to 1982, De Bondt and
Thaler (1985) rank all stocks traded on the NYSE by their prior three-year
cumulative return and form two portfolios: a “winner” portfolio of the thirty-
five stocks with the best prior record and a “loser” portfolio of the thirty-five
worst performers. They then measure the average return of these two port-
folios over the three years subsequent to their formation. They find that
over the whole sample period, the average annual return of the loser port-
folio is higher than the average return of the winner portfolio by almost 8
percent per year.
The Predictive Power of Scaled-price Ratios. These anomalies, which are
about the cross-sectional predictive power of variables like the book-to-
market (B/M) and earnings-to-price (E/P) ratios, where some measure of
fundamentals is scaled by price, have a long history in finance going back at
least to Graham (1949), and more recently Dreman (1977), Basu (1983),
and Rosenberg, Reid, and Lanstein (1985). We concentrate on Fama and
French’s (1992) more recent evidence.
Every year, from 1963 to 1990, Fama and French group all stocks traded
on the NYSE, AMEX, and NASDAQ into deciles based on their book-to-
market ratio, and measure the average return of each decile over the next
year. They find that the average return of the highest B/M-ratio decile, con-
taining so called “value” stocks, is 1.53 percent per month higher than the
average return on the lowest B/M-ratio decile, “growth” or “glamour”
stocks, a difference much higher than can be explained through differences
in beta between the two portfolios. Repeating the calculations with the
earnings–price ratio as the ranking measure produces a difference of 0.68
percent per month between the two extreme decile portfolios, again an
anomalous result.^24
Momentum. Every month from January 1963 to December 1989, Je-
gadeesh and Titman (1993) group all stocks traded on the NYSE into
deciles based on their prior six-month return and compute average returns
of each decile over the six months after portfolio formation. They find that
the decile of biggest prior winners outperforms the decile of biggest prior
losers by an average of 10 percent on an annual basis.
Comparing this result to De Bondt and Thaler’s (1985) study of prior
winners and losers illustrates the crucial role played by the length of the
prior ranking period. In one case, prior winners continue to win; in the
36 BARBERIS AND THALER
(^24) Ball (1978) and Berk (1995) point out that the size premium and the scaled-price ratio ef-
fects emerge naturally in any model where investors apply different discount rates to different
stocks: if investors discount a stock’s cash flows at a higher rate, that stock will typically have
a lower market capitalization and a lower price-earnings ratio, but also higher returns. Note,
however, that this view does not shed any light on whether the variation in discount rates is ra-
tionally justifiable or not.