Investors' Overreaction to an Extreme Event: Evidence from the World Trade Center Terrorist Attack
Posted: 14 Sep 2008 Last revised: 18 Jun 2009
Date Written: October 22, 2008
This paper investigates whether investors overreacted to the World Trade Center terrorist attack, using insurers' stock returns. Short-term abnormal return reversals are observed after the 9/11 attack. The reversals may reflect the substantially increased uncertainty surrounding insurer stocks after the event, meaning that the price reactions are efficient risk adjustments. However, after controlling for the change in risk, I still find evidence of price reversals, which I attribute to investor overreaction. To bolster this claim, I provide cross-sectional evidence that reversals are stronger for insurers with higher information asymmetry, which have wider ex-ante bid-ask spreads and smaller numbers of analysts following. This result indicates that the reversals are likely due to behavioral biases.
Keywords: September 11, Overreaction Hypothesis, Uncertain Information Hypothesis
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