Short Term Overreaction, Underreaction and Momentum in Equity Markets
45 Pages Posted: 10 Jul 2008 Last revised: 14 Jul 2008
Date Written: July 10, 2008
This paper extends the literature on market reaction to extreme price changes by introducing an empirical model that allows the conditional mean and variance of returns to vary asymmetrically in response to price changes of all sizes. We provide evidence, from US, UK and Japanese markets, that conditional returns do depend on the size and sign of previous price changes although there are strong indications that the effect has declined over time. We find support for the recently developed asset pricing models in which economic agents display behavioral biases and simultaneously underreact to some types of events and overreact to others. Our results show that the market tends to reverse after large price changes, while after small price changes a momentum type effect is observed.
Keywords: Equities, Overreaction, Underreaction, Trend Following
JEL Classification: G10
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