Overreaction Flashcards
Overreaction – De Bondt and Thaler
People put more emphasis on most recent past when predicting future, ie overreact to the most recent information. EX: PE ratio might be a manifestation of overreaction.
Their test was whether an overreaction reverses back or not. The result was overreaction to bad news bounce back earning abnormal return of 19%, and overreaction to good news was reverse back down to -5% earning ie loss for the test period. Overreaction is asymmetric long run effect; short run effect is a momentum effect.
Relationship of overreaction to other anomalies:
PE effect is really a manifestation of overreaction effect.
January effect is weakened since losers gain abnormal return – ie market is correcting previous overreaction to small stock
Overreaction is not driven by risk because β increases as stock become loser.???
FF did a test in an attempt to explain the anomalies R-rf = a + b (Rm-rf) + s SME + h HML +e
SME- return on small stock less big stock ie
HML - return on high BV/MV less return on low BV/MV
They are presence of overreaction.
Results: a to be insignificant, b is significant; s and h are also significant. They basically explain the abnormal returns. There is no such thing as overreaction after controlling these 3 factors. Essentially saying overreaction effect is irrelevant.
