Testing rational and behavioral predictions to long-term reversal: industry evidence from Latin America

The rational school predicts that return reversal may be significant in optimistic states but not in pessimistic ones. The behavioral school predicts that reversal may exist in industry segments with greater mispricing potential and more investor biases. We found little support for rational and behavioral predictions. After interacting rational and behavioral predictions, we found some evidence of reversal during bull markets for some industry segments. Nevertheless, after adjusting for systematic risk, long-term reversal turned out to be insignificant. Overall, our findings are consistent with the idea that return reversion at the industry level fails to generate abnormal profits.