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We design a new measure and find that the predictability of past returns on future returns increases as stocks respond with delay to firm-specific information. Our results suggest that momentum is caused by both investors' underre...
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We design a new measure and find that the predictability of past returns on future returns increases as stocks respond with delay to firm-specific information. Our results suggest that momentum is caused by both investors' underreaction and overreaction to information. However, underreaction to information seems to be the primary cause, particularly during the more recent period. Our findings are robust for recent explanations of momentum profits and alternative methods for computing our measure. We also find that stocks respond with delay to firm-specific information, partly due to certain firm characteristics, and partly because they escape investor attention due to their low visibility. Our paper extends and refines Jegadeesh and Titman's (J Financ 56(2):699-720, 2001) finding that momentum profits are consistent with behavioral models' predictions regarding investors' overreaction.
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The authors investigate the impact of language complexity on volatility using a novel measure based on the information-processing hypothesis of return volatility. The empirical analysis focuses on whether and how the executives ' ...
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The authors investigate the impact of language complexity on volatility using a novel measure based on the information-processing hypothesis of return volatility. The empirical analysis focuses on whether and how the executives ' use of complex language, measured by several linguistic attributes, contributes to the intraday return volatility following the earnings conference calls, that is, how the difficulty of incorporating more complex information into assets prices leads to increased volatility. Based on textual analysis of 98,955 quarterly earnings calls from June 2008 to December 2019, they find that the more complex the language used by executives during earnings conferences is, the higher the idiosyncratic volatility is immediately after the earnings calls. This impact of language complexity on volatility persists, in some cases, up to five days following the earnings call, even after controlling for earnings surprise and other firm characteristics, such as institutional ownership and short interest. The authors also find that the longer the time between the earnings release (announcement) and the start of the earnings conference call, the lower the idiosyncratic volatility after controlling for language complexity as well as the earnings surprise.
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Recent studies have proposed a large set of powerful anomaly-based factors in the stock market. This study examines the role of investor inattention in the corresponding anomalies underlying these factors and other underreaction-r...
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Recent studies have proposed a large set of powerful anomaly-based factors in the stock market. This study examines the role of investor inattention in the corresponding anomalies underlying these factors and other underreaction-related anomalies. Using media coverage as a proxy for investor attention, we show that the anomalies underlying many recently proposed prominent factors are much more pronounced among firms with low media coverage in portfolio-formation periods. In addition, we find many other prominent anomalies that previous literature has attributed to underreaction also tend to performmuch better among firms with low media coverage. The average Fama-French five-factor alpha spread of these anomalies is about 0.97% per month among firms with low news coverage and only 0.24% per month among firms with high news coverage. Moreover, most of the alpha spread comes fromthe short leg of the anomalies and fromthe firms that aremore difficult to arbitrage. Overall, our evidence indicates that investor inattention at least partially drivesmany of the recently proposed factors.
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In contrast to existing literature we implement experimental asset markets with fluctuating fundamental values following a stochastic process. Therefore we can measure traders' behavior in both bullish and bearish markets. We obse...
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In contrast to existing literature we implement experimental asset markets with fluctuating fundamental values following a stochastic process. Therefore we can measure traders' behavior in both bullish and bearish markets. We observe underreaction of price changes to changes in fundamental value which induces overvaluation in bearish and undervaluation in bullish markets. We also find an asymmetry between markets with bullish fundamental values and those with bearish ones as the former markets show a higher degree of informational efficiency. The reason for the observed underreaction lies in the relatively large volatility of the underlying fundamental value process.
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We compare the long run reaction to anticipated and surprise information announcements using stock splits. Although there is under-reaction in both cases, anticipated splits are treated differently to those that are unforeseen. Af...
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We compare the long run reaction to anticipated and surprise information announcements using stock splits. Although there is under-reaction in both cases, anticipated splits are treated differently to those that are unforeseen. After anticipated splits, cumulative abnormal returns peak at one-and-a-half times the level observed after unanticipated splits although the time taken for the announcement to be absorbed into prices is the same. We explain the difference in underreaction by the degree to which split announcements are believed and hence invested in. The favorable signal conveyed in forecast splits is more credible owing to their better pre-split performance, resulting in a far more pronounced underreaction effect.
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Although price trends such as momentum and reversal patterns of stock prices are well established in the literature, little is known whether price patterns still hold at the international level. Using data from over 24,000 stock p...
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Although price trends such as momentum and reversal patterns of stock prices are well established in the literature, little is known whether price patterns still hold at the international level. Using data from over 24,000 stock prices, the analysis forms international within and across industries portfolios for the EU and the Asia/Pacific regions and studies the presence of momentum and reversal patterns, compared with the typical benchmark, which is the U.S. market. Interestingly, it finds that both patterns are related to low capitalized firms. Price reversals appearing only at the short-run validating the liquidity constraint assumption, while momentum holds for a longer period and is related to investors' underreaction. Finally, it finds that only a few sectors can predict the market as an indirect result of momentum. A trading strategy that builds on industries' portfolios own predictive ability beats the market. Overall, matching returns patterns from the national to the international level supports the presence of unobserved risk factors and behavioural biases.
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We present an experiment where subjects sequentially receive signals about the true state of the world and need to form beliefs about which one is true, with payoffs related to reported beliefs. We attempt to control for risk aver...
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We present an experiment where subjects sequentially receive signals about the true state of the world and need to form beliefs about which one is true, with payoffs related to reported beliefs. We attempt to control for risk aversion using the Offerman et al. (Rev Econ Stud 76(4):1461-1489, 2009) technique. Against the baseline of Bayesian updating, we test for belief adjustment underreaction and overreaction and model the decision making process of the agent as a double hurdle model where agents with inferential expectations first decide whether to adjust their beliefs and then, if so, decide by how much. We also test the effects of increased inattention and complexity on belief updating. We find evidence for periods of belief inertia interspersed with belief adjustment. This is due to a combination of random belief adjustment; state-dependent belief adjustment, with many subjects requiring considerable evidence to change their beliefs; and quasi-Bayesian belief adjustment, with aggregate insufficient belief adjustment when a belief change does occur. Inattention, like complexity, makes subjects less likely to adjust their stated beliefs, while inattention additionally discourages full adjustment.
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This paper models overreaction/underreaction as being the outcome of company managers' choices to manipulate earnings in response to perceived mispricing of their company. One of the more prominent attempts to reconcile observed s...
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This paper models overreaction/underreaction as being the outcome of company managers' choices to manipulate earnings in response to perceived mispricing of their company. One of the more prominent attempts to reconcile observed short-term overreaction and consequent secular underreaction to earnings news interprets earnings announcements as 'selective' events. In financial markets events are 'selected' when contrived in response to perceived asset mispricing. We interpret earnings management by managers as a process requiring a selection of earnings in response to perceived mispricing of their corporation's stock. Post-earnings announcement drift is then interpreted as one consequence of this form of managerial choice. We devise and test a trading strategy, implemented at the earnings announcement date, based on the level of discretionary accruals in relation to past mispricing. The profitability of such a strategy is tested and conclusions for attempts to reconcile short-term overreaction with secular underreaction are drawn.
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This study examines the relationship between systematic liquidity risk and stock price reaction to large 1-day price changes (or shocks). We base our analysis on a yearly updated constituents list of the FTSE All share index. Our ...
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This study examines the relationship between systematic liquidity risk and stock price reaction to large 1-day price changes (or shocks). We base our analysis on a yearly updated constituents list of the FTSE All share index. Our overall results are consistent with the price continuation hypothesis, which suggests that positive (negative) shocks will be followed by positive (negative) abnormal returns. However, further analysis indicates that stocks with low systematic liquidity risk react efficiently to both positive and negative shocks, whereas stocks with high systematic liquidity risk underreact to both positive and negative shocks. Our results are valid irrespective of various robustness tests such as size of the shock, size of the firm, month-of-the-year and day-of-the-week effects. We conclude that trading on price patterns following shocks may not be profitable, as it involves taking substantial liquidity exposure.
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Policy scholars tend to view disproportionate policy and its two component concepts - policy over- and underreaction - as either unintentional errors of commission or omission, or nonintentional responses that political executives...
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Policy scholars tend to view disproportionate policy and its two component concepts - policy over- and underreaction - as either unintentional errors of commission or omission, or nonintentional responses that political executives never intended to implement yet are not executed unknowingly, inadvertently or accidentally. This article highlights a conceptual turn, whereby these concepts are reentering the policy lexicon as types of intentional policy responses that are largely undertaken when political executives are vulnerable to voters. Intentional overreactions derive from the desire of political executives to pander to voters' opinions or signal extremity by overreacting to these opinions in domains susceptible to manipulation for credit-claiming purposes. Intentional underreactions are motivated by political executives' attempts to avoid blame and may subsequently lead to deliberate overreaction. This conceptual turn forces scholars to recognise the political benefits that elected executives may reap from deliberately implementing disproportionate policies, and that such policies can at times be effective.
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