Overreaction hypothesis in the uk stock market essay

Conclusion By Nathan Reiff The concept of market efficiency assumes that new information about a security will be reflected more or less instantaneously in the price of that security in the market.

Overreaction hypothesis in the uk stock market essay

Get Full Essay Get access to this section to get all help you need with your essay and educational issues. Recent Developments in Banking Sector in the UK Essay Sample Abstract While there are many interesting and challenging development taking place in the banking sector in the UK at the moment, investment banking has always been the field in which the most important strategic developments take place.

A certain development is of particular interest in case it contradicts or disproves a certain economic theory. Recently, there have been debates in the UK banking sector on the subject of a possibility of earning above-average returns on observing stock market overreaction.

Some empirical data emerged suggesting that it might be the case. In this light, the efficient market hypothesis is applied to the analysis of this possibility.

Objectives of the Research To review the body of literature available to date on the subject of stock market overreaction; To assess the viabiloity of the efficient market hypothesis based on both theoretical and empirical studies; To answer the question whether it is possible to earn abnormal returns on observing stock market overreaction; To suggest directions for further research.

Introduction The efficient market hypothesis states that share prices reflect all information available to market participants and that, by implication, share price changes cannot be predicted thus precluding any abnormal profit opportunities. However, a number of recent studies challenge this hypothesis by showing that past prices can predict future movements in prices and that investment strategies based on historical returns can generate subsequent risk-adjusted abnormal returns.

These trading strategies are based on the notion that markets have a tendency to over- and under-react. The research reported analyses variances in stock prices of one-day loss making companies and their performance in the next consecutive trading day.

Numerous researchers have produced a collection of evidence to support the overreaction hypothesis. They discover a mixture of findings which suggest that extreme movements in stock prices are followed by price movements in the opposite direction as market participant comprehend they have overreacted, and that the larger the price movement, the larger the reversal that follows.

The efficient markets hypothesis and the random walk theory that preceded it are perhaps the most misunderstood concepts in the theory of investment. But making money from buying and selling securities on the capital markets is not, as many suppose, a matter of being able to predict the winners by studying the past.

According to the EMH, such forecasts are nothing more than elaborate guess-work which, on average, are unlikely to be accurate Baumol, ; Brown and Warner, ; Keane, ; Gencay, ; Shleifer, ; Blake, However, if the market is inefficient it regularly prices securities incorrectly, allowing a perceptive investor to identify profitable trading opportunities.

It is this that provides the fundamental reason for this paper. The general consensus is that if no one can beat the market it is efficient, and conversely, inefficient if it is possible to beat the market.

Over the decades numerous researchers have claimed to have developed a strategy which guarantees investors to beat the market. This subject is commonly presented with many influential articles; none more so than those based around stock market overreaction.

However, conclusion is yet to be reached on whether or not it is possible to achieve above-average returns by manipulating stock market overreaction. If it appears that the market has overreacted and that large changes in the prices of individual securities are followed by a reversal this could be interpreted as being at variance with the efficient market hypothesis.

If this is the case, a specific trading rule could be applied in order to make short-term profit based on observing the previous days trading.

Overall there has been extensive research on the subject of stock market overreaction. The overreaction hypothesis postulates that investors respond too strongly to unfavourable and favourable information. This is a highly controversial and often disputed area causing much emotion and argument in investment circles.

Efficient-market hypothesis - Wikipedia

The issue is not a simple one. Numerous researchers including both practitioners and academics have published literature on the subject of stock market overreaction. The views held range from total belief in market efficiency to total disbelief, with various degrees of scepticism in between.

Therefore it is difficult to distinguish who is right and who is wrong and hence this research paper must consider every angle in order to reach a sound conclusion.Critical analysis of the implication of overreaction to the return predictability in UK stock market Over the past decades, overreaction has drawn attention from many economic researchers, the most significant studies being Jegadeesh and Titman, (), De Bondt and Thaler () proving the existence of .

Abstract. This paper investigates the evidence on the stock market overreaction hypothesis (ORH), which holds that, if stock prices systematically overshoot as a consequence of excessive investor optimism or pessimism, price reversals should be predictable from past price performance.

Overreaction is an emotional response to news about a security, led by either greed or fear, which causes it to become either overbought or oversold. Fallen Angels: The investment opportunity Clare and S.H. Thomas, The information content of credit rating changes in the UK stock market, The Journal of Business Finance and Accounting, (), Vol.

24, DeBondt and Richard Thaler7 tested the overreaction hypothesis using US stock data. What they found. Stock prices in the beginning of extremely bad news fall below their justified equilibrium price in the market and extremely good news has the reversal impact on the stock prices.

This study investigates the overreaction hypothesis in the listed companies of Cement sector of KSE listed companies. This study mainly supports the Overreaction Hypothesis in the Inter-industry and the intra-sector environment of the UK stock market.

Overreaction hypothesis in the uk stock market essay

Firstly, it contradicts Haugen, () plausible hypothesis that long-term reversals should not exist when value-weighted industry indexes are used in order to find it.

The Overreaction Hypothesis - feelthefish.com