Market overreaction: Magnitude and intensity

The rationality of financial markets has been widely debated for a long time. In this study, one particular type of irrational behavior -- the tendency of investors to overreact to dramatic events -- is addressed through analysis of security returns from CRSP for the period January 1946-December 198...

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Bibliographic Details
Published in:Journal of portfolio management 1988-01, Vol.14 (2), p.6-13
Main Authors: Brown, Keith C, Harlow, W V
Format: Article
Language:English
Subjects:
Efficient markets
Hypotheses
Investors
Responses
Securities markets
Statistical analysis
Stock prices
Studies
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Summary:The rationality of financial markets has been widely debated for a long time. In this study, one particular type of irrational behavior -- the tendency of investors to overreact to dramatic events -- is addressed through analysis of security returns from CRSP for the period January 1946-December 1983. Focusing on the residual losses and gains of individual securities, investor responses to events that differed in both intensity and magnitude are isolated. The results clearly show that how market participants react to extreme price movements is critically dependent upon the direction of the initial change. For positive events, only mild evidence was found that investors set prices in any way other than efficiently. The evidence on short-term corrections to negative events corresponds strongly with the Overreaction Hypothesis. However, the average long-term reaction more than offsets any corrective action in the first month following the event.
ISSN:0095-4918
2168-8656
DOI:10.3905/jpm.1988.409137