Motivated by theoretical and empirical evidence that investors’ continuing overreaction generates price momentum, we propose a measure based on weighted monthly signed volumes that directly captures continuing overreaction, and examine whether it predicts
future stock returns. We find that the strategies of buying stocks that have experienced continuing overreaction on the positive side and selling stocks that have experienced continuing overreaction on the negative side generate significant positive returns over
intermediate horizons. These results are robust to controls for size, book-to-market, momentum, short-term reversals, liquidity, idiosyncratic volatility, turnover, return consistency, and information discreteness. Furthermore, momentum profits disappear after
controlling for the continuing overreaction effect. Our results provide direct support for the behavioral model of Daniel, Hirshleifer, and Subrahmanyam (1998) that investor overreaction resulting from overconfidence and biased self-attribution drives stock return predictability.
Keywords: overreaction, overconfidence
