Market Overreaction: Magnitude and Intensity
Keith C. Brown
W. V. Harlow
Journal of Portfolio
Management
14, 1988, pp. 6-13
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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