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The profitability of contrarian investment strategies need not be the result of stock market overreaction. Even if returns on individual securities are temporally independent, portfolio strategies that attempt to exploit return reversals may still earn positive expected profits. This is due to the effects of cross-autocovariances from which contrarian strategies inadvertently benefit. We provide an informal taxonomy of return-generating processes that yield positive [and negative] expected profits under a particular contrarian portfolio strategy, and use this taxonomy to reconcile the empirical findings of weak negative autocorrelation for returns on individual stocks with the strong positive autocorrelation of portfolio returns. We present empirical evidence against overreaction as the primary source of contrarian profits, and show the presence of important lead-lag relations across securities.

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We develop a stochastic model of nonsynchronous asset prices based on sampling with random censoring. In addition to generalizing existing models of non-trading our framework allows the explicit calculation of the effects of infrequent trading on the time series properties of asset returns. These are empirically testable implications for the variances, autocorrelations, and cross-autocorrelations of returns to individual stocks as well as to portfolios. We construct estimators to quantify the magnitude of non-trading effects in commonly used stock returns data bases and show the extent to which this phenomenon is responsible for the recent rejections of the random walk hypothesis.