Does the stock market overreact?

Article Abstract:

Analysis of monthly returns for common stocks listed on the New York Stock Exchange from 1926 to 1982 indicates that investors overreact to unexpected events. The data analyzed were accumulated by the University of Chicago's Center for Research in Security Prices. The analysis supports the two main contentions of the overreaction hypothesis, namely that: (1) price adjustments follow extreme stock price movements and these adjustments necessarily move in the opposite direction from the initial price movement; and (2) the more extreme the initial price movement, the more extreme the price adjustment. The reasons for these extreme price movements and their predictability are also discussed. A discussion following the research presentation suggests that investor emphasis on short-term information explains these market swings, and that the stock market is not as inefficient as the research states.

Psychological aspects, United States, Stock-exchange, Stock exchanges, Stock transfer

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Further evidence on investor overreaction and stock market seasonality

Article Abstract:

In a previous paper, we found systematic price reversals for stocks that experience extreme long-term gains or losses: Past losers significantly outperform past winners. We interpreted this finding as consistent with the behavioral hypothesis of investor overreaction. In this follow-up paper, additional evidence is reported that supports the overreaction hypothesis and that is inconsistent with two alternative hypotheses based on firm size and differences in risk, as measured by CAPM-betas. The seasonal pattern of returns is also examined. Excess returns in January are related to both short-term and long-term past performance, as well as to the previous year market return. (Reprinted by permission of the publisher.)

Prices and rates, Stock prices, Investors, Seasonal variations (Economics), Financial research

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Caveat compounder: a warning about using the daily CRSP equal-weighted index to compute long-run excess returns

Article Abstract:

This paper issues a warning that compounding daily returns of the Center for Research in Security Prices (CRSP) equal-weighted index can lead to surprisingly large biases. The differences between the monthly returns compounded from the daily tapes and the monthly CRSP equal-weighted indices is almost 0.43 percent per month, or 6 percent per year. This difference amounts to one-third of the average monthly return, and is large enough to reverse the conclusions of a paper using the daily tape to compute the return on the benchmark portfolio. We also investigate the sources of these biases and suggest several alternative strategies to avoid them. (Reprinted by permission of the publisher.)

Statistics, Return on investment, Rate of return, University of Chicago. Center for Research in Security Prices

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