Contrarian strategies and investor expectations: The UK evidence

The rationale for the superior performance of contrarian investment strateg ies remains a matter of lively debate. The orthodox view maintains that suc h strategies generate higher returns because they are fundamentally riskier , whereas the behaviorists suggest that the superior performance is a resul t of systematic errors in investors' expectations about the future. If the behavioral view is accepted, then the debate centers on what the underlying source(s) of such errors are-naive extrapolation of past performance or bi ased analysts' earnings forecasts. Using stocks listed on the London Stock Exchange, we found evidence consistent with the view that errors in expecta tions are more likely to be a result of biases in analysts' earnings foreca sts than naive extrapolation of the past. We also found that positive and n egative earnings surprises have an asymmetrical effect on the returns of lo w- and high-rated stocks. Positive earnings surprises have a disproportiona tely large positive impact on stocks that are priced low relative to four m easures of operating performance; negative surprises have a relatively beni gn effect on such stocks.