The Adjustment of Stock Prices to Completely Unanticipated Events

Abstract

This paper utilizes standard cumulative residual analysis to study the response of stock prices to completely unanticipated events—fatal commercial airline crashes. Results indicate that the immediate negative reaction to fatal airline crashes is significant for only one full trading day after the event occurs. Hence, the market appears to assimilate the new information rapidly, even if the crash occurs in a remote geographic location. The paper also considers market response after the initial reaction period by assuming that the actual cumulative average residuals are drawn from the same distribution as the pre‐crash base period and by calculating the probabilities that observed changes would occur. Results provide no evidence that underreaction or overreaction appeared in the initial response period. The hypothesis of complete, immediate adjustment is also supported by a repetition of the analysis on the subsample of airplane crashes where the greatest potential loss occurs.

Testing equity market efficiency around terrorist attacks

“…The first is that -on the four occasions when an equity market did move by more than 1% following one of these totally unexpected attacks -first market reaction occurred within about 20-40 minutes and was largely completed within another hour. This suggests that markets are very efficient in quantifying the financial impacts of terrorist events, and matches other evidence that markets take well under a trading day to price in completely unanticipated impacts such as aircraft crashes (Barrett et al, 1987).…”

War and stock markets: The effect of World War Two on the British stock market

“…With such strong and varied evidence of small and economically unimportant events having effects on returns, it is quite surprising that some very major events such as armed conflict have not received the same level of attention in the academic literature. A few types of major events, not directly related to conflict have been explored such as airplane crashes (Barrett et al 1987;Davidson et al 1987;Kaplanski and Levy 2010), hurricanes (Lamb 1995(Lamb , 1998Angbazo and A C C E P T E D M A N U S C R I P T…”

Updating expectations: An analysis of post-9/11 returns

“…2 Numerous studies have documented market overreaction. 3 Other studies find under-reaction. 4 In addition, researchers have documented that markets appear to be "too volatile," in the sense that prices move much more than the levels justified by changes in "fundamentals."…”

“…More recently, Chan (2003) shows that bad news leads to significantly longer drift in prices than good news. See also Barrett et al (1987), Lamb (1995), Veronesi (1999), and Carter and Simkins (2002). 4 Cohen et al (2002) is a recent example.…”

“…2 In particular, a number of studies have examined how bad news concerning a bank's clients can affect the price of bank stocks; see, for example, Smirlock and Kaufold (1987) or Sinkey and Carter (1999). 3 DeBondt and Thaler (1985,1987) address the link between mean reversion and investor over-reaction, showing that portfolios formed from poor performers had significantly higher abnormal returns than portfolios formed from good performers. The latter paper focuses on the impact of time varying risk premia.…”