Recent Evidence on International Stock Markets Overreaction

Alves, Paulo and Carvalho, Luís (2020): Recent Evidence on International Stock Markets Overreaction.

Abstract

Investors are told to be overreacting when their sentiment drives the price of a certain security up (down) enough to make it the biggest winners (loser), in most cases considering this overreaction period as long as 3 or 5 years. This paper studies the overreaction hypothesis in market indices. Using end of month data from December 1970 to December 2018 from 49 Morgan Stanley Capital International Indices we studied the overreaction hypothesis on Market Indices for 3- and 5-years’ investment periods. Instead of Cumulative Average Returns the returns were computed as Holding Period Returns to avoid the upward bias. We found strong return reversals for 3-year investment periods, which were statistically significant at a 5% significant level. However, the returns might be weaker depending on the time period we consider. When implemented only in developed markets there is still evidence which supports the overreaction hypothesis, although the excess returns are economically weaker. Evidence for the overreaction hypothesis was also found when 5-year investment periods were considered. Not only did losers outperform winners, but they were also less risky than winners. Regardless of the market, investment period and/or time-period considered, losers’ portfolio beta was always smaller than the winners’ portfolio beta. Notwithstanding these results, the overreaction strategy is sensitive to the time periods considered which highlights the possibility that the overreaction strategy success it’s not time stationary.

• Item Type: MPRA Paper
• Language: English
• Keywords: Market indices, overreaction hypothesis, winner-losers’ reversals
• Subjects: G - Financial Economics > G0 - General > G02 - Behavioral Finance: Underlying Principles; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading

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