This paper presents a decomposition of short-horizon contrarian profits into various sources based on an analysis os stock price reactions to common factors an firm-specific information. In sharp contrast with the conclusions in the extant literature, we find that the lead-lag structure in stock prices contributes less than 5% of the observed contrarian profits with most of the profits being attributable to stock price overreaction.

This paper shows that the pattern of short term negative serial covariances for stock returns over different return measurement intervals is consistent with the implications of inventory-based market microstructure models. The results of the tests developed in this paper indicate that the short horizon return reversals can to a large extent be explained by transitory components in prices related to imbalances in specialists’ inventory positions. The evidence also suggests that the stock market may be as liquid or resilient as suggested by some earlier studies.