Contrarian investing in a small cap market: evidence from New Zealand

Abstract

Using various accounting-based valuation ratios and cross-sectional stock returns of NZSE firms, we investigate the applicability of accounting-based contrarian investment strategies in the small, open New Zealand market. Long horizon returns generated from these strategies are examined. The observed return patterns of these strategics are then related to risk-based and behavioral-based explanations of the contrarian anomaly. We find that while glamour stock portfolios outperform value portfolios in the first year following portfolio formation, the value portfolios significantly outperform their glamour counterparts thereafter. These results imply that the contrarian anomaly in Nc\V Zealand cannot be due to a risk-based explanation; rather, our findings suggest that contrarian strategics earn higher returns because they exploit the expectation errors of naive investors. This also implies that New Zealand investors, like investors in other developed markets, do not consider mean reversion of stock returns or firm profitability in their investment decision making.