Do Stock Market Investors Overreact?

Abstract

This paper investigates the evidence on the stock market overreaction hypothesis (ORH), which holds that, if stock prices systematically overshoot as a consequence of excessive investor optimism or pessimism, price reversals should be predictable from past price performance. The ORH stands in contradiction to the efficient markets hypothesis which is a cornerstone of financial economics. This study is unique in the overreaction literature because it is restricted to larger and better-known listed companies, whose shares are more frequently traded. This restriction more or less eliminates two alternative explanations to the overreaction hypothesis: it minimises the influence of bid-ask biases and infrequent trading, and reduces the possibility that reversals are primarily a small-firm phenomenon. The paper also investigates a third alternative explanation, namely that time-varying risk explains the reversal effect. The study employs unbiased methods of return computation and uses data from 1975 to 1991 for nearly 1,000 UK companies. Overall, the evidence appears to be consistent with the overreaction hypothesis, subject to certain qualifications. Copyright Blackwell Publishers Ltd 1997.

Long-Term Stock Price Reversals in the Uk: Evidence From Regression Tests

“…9 The average size of the past returns coefficient was 0.112, which is statistically significant from zero at the 5% level-these results are entirely consistent with those based on contrarian portfolio tests in Dissanaike (1997). It is worth noting that the size of the coefficient, even when it bore the expected sign, was quite unstable, ranging from 0.021 in period 2 to 0.39 in period 5.…”

“…The present study uses a 4-year return horizon and, therefore, belongs to the long horizon literature. We use a 4-year interval because our aim is to compare the regression results with the contrarian portfolio results of Dissanaike (1997) and offer an added check using regression tests. The 4-year interval was the horizon given prominence in the Dissanaike (1997) paper.…”

“…2 Many of the major studies of long-term stock price reversals have analysed US data, prompting fears about data snooping biases. There have been comparatively few UK studies of this topic and these investigations have not comprehensively examined all the related issues (Power, Lonie & Lonie, 1991;Dissanaike, 1994aDissanaike, , 1997Clare & Thomas, 1995). The UK studies differ with respect to the periods studied and the methodology used, but are similar in that they have all employed contrarian portfolio techniques to identify evidence of price reversals.…”

“…For reasons of comparison, we employ the same data set used by Dissanaike (1997), who found evidence consistent with the overreaction hypothesis using contrarian portfolio tests. The study is therefore restricted to approximately 1000 of the larger and better-known UK companies, whose shares are more frequently traded on the London Stock Exchange.…”

House Prices and Bubbles in New Zealand

“…13 At the heart of such an argument is the concept of arbitrage, which in housing markets is impeded by the fact that the asset is heterogeneous, is traded in a highly segmented 11 If bubbles are uncorrelated with fundamentals, in order to be arbitrage free they must be expected to grow at a rate of 1+ρ per period and the bubble and fundamentals will be driven apart at an explosive rate. 12 There exists a large literature on stock market overreaction including evidence on predictability (see for example Dissanaike, 1997, using U.K. data) and overreaction persistence (see for example Chen & Sauer, 1997, using U.S. data). 13 It is important to note, however, that other 'rational' explanations are observationally equivalent to the intrinsic bubble explanation: regime shifts and managed fundamentals, can also explain nonlinearities in the price-fundamental process (Froot & Obstfeld, 1991;Ackert & Hunter, 1999 Alternatively, prolonged deviations from fundamental value can be due to socalled momentum investor behavior driven by price alone, 14 whereby agents buy after price increases and sell after price decreases (see evidence from stock markets, for example Shiller, 1984;Kyle, 1985;DeLong et al, 1990;Daniel et al, 1998;Barberis et al, 1998;Hong & Stein, 1999;Lui et al, 1999).…”