Market Overreaction: Magnitude and Intensity

 

Keith C. Brown

W. V. Harlow

 

Journal of Portfolio Management 14, 1988, pp. 6-13

 

 

Abstract

                       

Recently, the notion that investors in the stock market tend to overreact to financial events of a dramatic nature has received a considerable amount of attention.  The purpose of our paper is to critically reexamine the Overreaction Hypothesis (OH), which is extended to suggest that: (i) extreme movements in equity prices will be followed by movements in the opposite direction, (ii) the more extreme the initial price change, the more extreme the offsetting reaction, and (iii) the shorter the duration of the initial price change, the more extreme the subsequent response.  Using a test procedure designed to isolate a sample of unsystematic price changes, we demonstrate that a subsequent market correction of the type predicted by the OH exists only for those events associated with extreme price declines.  Since this response is limited to the first month following a “negative” event and since no systematic correction is observed to occur after extreme price increases, we conclude that the tendency toward stock market overreaction is best regarded as an asymmetric, short-term phenomenon.

 

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