Extreme Return Extrapolation

We propose that extrapolative beliefs about recent past extreme returns contribute to a better understanding of the source and outcome of extreme positive daily returns. In an extrapolation framework, investors may overestimate the likelihood of future extreme positive daily returns for stocks with such a recent history of salient returns, leading to lower future returns for these stocks than for their counterparts without such a historical return pattern. Moreover, the return predictability is stronger when past extreme positive daily returns occur more recently. Our results are robust to controlling for skewness preferences, investor attention, and firm fundamental shocks and strength.