Does the Stock Market Overreact?

Topics: Efficient-market hypothesis, Stock market, Bond Pages: 3 (916 words) Published: April 21, 2013
This paper we prepared by Werner F. De B, and Richard T in 1985 in the Journal of Finance. The paper investigates the reaction on stock prices after the announcement of related news. Specifically, the paper aims at finding whether the stock overreaction to such news is predictive or not. Using the empirical test, the paper was preformed by obtaining monthly return for 85 consecutives periods. The findings of this paper are: first, the overreaction effect is larger for losers’’ firms than winners, knowing that such effect is asymmetric. Second, most firms realize excess return on January, “seasonality effect”, as well the announcements’ periods for most firms. Lastly, the overreaction effect happens at the second and third testing periods.

The paper in based on data collected for stocks that have to have their earnings available for a consecutive 85 months. This may result in sample selection bias given that the data were collected in 1985, and only large firms will be applicable to these criteria. In additions, the authors of this paper used monthly return to measure and predict the overreaction effect, yet, a stock price can corrects its self to the normal price before the end of the month. For example, when blackberry announced its new phone on Feb 4, 2013, the stock realized a capital gain of 15% in that day. However, the ten-days average earnings for the prior and post announcement day is relatively the same, (-1%, 0% respectively).

When looking at the data used for this research, one finds that the researchers did not adjust for the fact that the stock movement is positive over time, nor they accounted for the effect of random walks that can be reflected in stocks earnings. Also, if we agree that there is an overreaction effect, then, we also agree there is a correction process for the stock prices. Thus, some of these earnings might include the effect of this correction process, whether it’s a positive or negative correction movement.

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