The monetary environment and long-run reversals in stock returns

Previous research attributes long‐run reversals to investor overreaction or tax‐motivated trading; we offer an alternative explanation based on the monetary environment. Prices rebound for stocks that have performed poorly over the past several years (losers); however, the rebound occurs only during expansive monetary conditions. Winners only reverse course when monetary conditions are restrictive. Past research shows that the three‐factor model explains long‐run stock reversals; we show that the monetary environment plays an instrumental role in the observation. Finally, we show that reversal patterns are closely linked to both the monetary environment and a firm's level of financial constraints.