De Bondt, W. F. M., & Thaler, R. H. (). Does the stock market overreact. Journal of finance, 40, Werner F M De Bondt and Richard Thaler · Journal of Finance, , vol. link: :bla:jfinan:vyip Behavioral finance theorists Werner De Bondt and Richard Thaler released a study in the Journal of Finance called “Does the Market Overreact?” In their .
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Twelve months into the test period, the difference in performancebetween the extreme portfolios is a mere 5. Handbook of the Economics of Finance 1, This rule-of-thumb,an instance of what Kahneman and Tversky call the representativeness heuristic, violates the basic statistical principal that the extremeness of predictions must be moderatedby considerationsof predictability. For, even if we knew the “correct” model of Em Rjt IFm it would explain only small part of the variation l1in Pit.
When a security is delisted, suspendedor halted, CRSP determineswhether or not it is possible to trade at the last listed price. As shown in-De Bondt , the use of market-adjusted excess returns has the further advantage that it is likely to bias the research design against the overreaction hypothesis. If stock prices systematically overshoot, then their reversal should be predictable from past return data alone, with no use of any accounting data such as earnings.
We begin by describing briefly the individual and market behavior that piqued our interest. Since, for any period t, the same constant market return Rlmt subtracted from all Rjt’s, the results are interpretablein terms of is raw dollar returns. Therefore, the empirical analysis is based on three types of return residuals: Journal of PortfolioManagement10 Winter As time goes on and new securities appear on the tape, more debnodt more stocks qualify for this step.
Does the stock market overreact? An equally weighted arithmetic average rate of return on all CRSP listed securities serves as the market index. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive.
Werner De Bondt
This result may be due to his particular definition of the tax-loss selling measure. What are the equilibria conditions for marketsin which some agents are not rational in the sense that they fail to revise their expectations accordingto Bayes’ rule? As the cumulative average residuals during the formation period for various sets of winner and loser portfolios grow larger, so do the subsequent price reversals, measured by [ACARL,t – ACARw,] and the accompanying t-statistics. De Bondt  formally derives the econometric biases in the estimated marketadjusted 1895 market model residuals if the “true”model is multifactor, e.
In order to check whether the choice affects the results, some of the empirical tests use May as the portfolio formation month. Secondly, consistent with previous work on the turn-of-the-year effect and seasonality, most of the excess returns are realized in January.
People seem to make predictions according to a simple matching xebondt What is an appropriatereaction?
While the overreactionhypothesis has considerablea priori appeal,the obvious question to ask is: Most importantly,the extraordinarilylarge positive excess returns earned by the loser portfolio in January.
The overreactioneffect deserves attention because it represents a behavioralprinciple that may apply in many other contexts. One class,of tasks which have a well-established norm are probability revision problemsfor which Bayes’ rule prescribesthe correctreactionto new information. Thus, the loser portfolios not only outperformthe winnerportfolios;if the CAPM is correct, they are also significantly less risky.
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EconPapers: Does the Stock Market Overreact?
New articles related to this author’s research. In spite of the observedtrendiness of dividends, investors seem to attach disproportionate importanceto short-run economic developments. An easy way to generate more less extreme observations is to lengthen shorten the portfolio formationperiod;alternatively, for any given formation period say, two yearswe may compare the test period performance of less versus more extreme portfolios, e.
If a security’s return is missing in a month subsequentto portfolio formation,then, from that moment on, the stock is permanently droppedfrom the portfolio and the CAR is an average of the availableresidualreturns. But all three experiments are clearly affected by the same underlyingseasonal pattern. Clearly,the numberof independent replicationsvaries inversely with the length of the formationperiod.
Journal of political Economy 98 6, For a formation period as short as one year, no reversal is observed at all.
The problem is particularlysevere with respect to debonrt winner portfolio. There ‘ Of course,the variabilityof stock prices may also reflect changes in real interest rates.
Several aspects of the results remain without adequate explanation; most importantly,the large positive excess returns earned thzler the loser portfolio every January. We discuss the implications for other empirical work on asset pricing anomalies. Much to our surprise, the effect is observed as late as five years after portfolio formation. This systematic bias may be responsible for the earlier observed asymmetryin the return behavior of the extreme portfolios.
Over the last half-century, loser portfolios of 35 stocks outperformthe market by, on average, Reinganum  has claimed that the small firm effect subsumes the PIE effect and that both are related to the same set of missing and againunknown factors. Winner portfolios, on the thlaer hand, earn about 5. The term overreaction carries with it an implicit comparison to some degree of reaction that is consideredto be appropriate. As long as the variation in Em R? Publisher contact information may be obtained at http: Email htaler for updates.