Does the Stock Market Overreact?

Authors

  • WERNER F. M. De BONDT,

  • RICHARD THALER

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    • University of Wisconsin at Madison and Cornell University, respectively. The financial support of the C.I.M. Doctoral Fellowship Program (Brussels, Belgium) and the Cornell Graduate School of Management is gratefully acknowledged. We received helpful comments from Seymour Smidt, Dale Morse, Peter Bernstein, Fischer Black, Robert Jarrow, Edwin Elton, and Ross Watts.


ABSTRACT

Research in experimental psychology suggests that, in violation of Bayes' rule, most people tend to “overreact” to unexpected and dramatic news events. This study of market efficiency investigates whether such behavior affects stock prices. The empirical evidence, based on CRSP monthly return data, is consistent with the overreaction hypothesis. Substantial weak form market inefficiencies are discovered. The results also shed new light on the January returns earned by prior “winners” and “losers.” Portfolios of losers experience exceptionally large January returns as late as five years after portfolio formation.

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